Internationalization Decisions: The Effects of Country Similarities

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Internationalization decisionsHotho, J.

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Internationalization Decisions: The Effects of Country Similarities

and Familiarity Perceptions

Jasper J. Hotho

Publisher: PPI Publishers

Postbus 333 7500 AH Enschede The Netherlands

Printed by: PrintPartners Ipskamp, Nederland ISBN: 978–90–367–3992–4 ! 2009 Jasper J. Hotho

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RIJKSUNIVERSITEIT GRONINGEN

Internationalization Decisions: The Effects of Country Differences

and Familiarity Perceptions

Proefschrift

ter verkrijging van het doctoraat in de Economie en Bedrijfskunde

aan de Rijksuniversiteit Groningen op gezag van de

Rector Magnificus, dr. F. Zwarts, in het openbaar te verdedigen op

donderdag 8 oktober 2009 om 14:45 uur

door

Jasper Jaap Hotho geboren op 8 juni 1981

te Warnsveld

Promotores : Prof. dr. A.M. Sorge

Prof. dr. H. van Ees

Beoordelingscommissie : Prof. dr. M. Geppert Prof. dr. L. Karsten Prof. dr. N.G. Noorderhaven

Acknowledgements I have been fortunate that many people have supported and encouraged me during the writing of this Ph.D. dissertation. I am very grateful to all these friends, colleagues and relatives whose support made writing this dissertation not merely more bearable, but actually enjoyable. There are several individuals who deserve special mention for their contributions to this dissertation, and I would like to take this opportunity to express my gratitude for their support.

First of all, I would like to thank my supervisors Arndt Sorge and Hans van Ees for their suggestions and comments, for their careful, critical reading of the chapters in this book as well as all the preliminary papers and tentative research ideas which preceded these chapters, and for their unflagging encouragement and support. As a supervision team they proved to complement each other perfectly, and I’m very grateful that it has been them who have helped me mature into a young IB scholar.

I would also like to take this opportunity to thank the reading committee, consisting of Professors Mike Geppert, Luchien Karsten and Niels Noorderhaven, for reading and assessing this Ph.D. thesis and for their encouraging comments.

Then, I am very much indebted to two colleagues at the University of Groningen who have made vital contributions to the completion of this dissertation; Jutta Bolt and Christoph Dörrenbächer. Jutta is the co-author of the paper on which Chapter 4 is based. This paper started off as a submission to the SOM Ph.D. Essay competition 2006 (which, coincidentally, we happened to win) and the ideas in that essay very much formed the starting point for the main argument in this thesis. I thank her for helping me discover the joy of writing together, and for her support during the numerous review rounds and revisions this essay has since undergone.

I thank Dr. Christoph Dörrenbacher for the invaluable help he provided in getting access to the German publishing house on which the case study in Chapter 5 is based. Christoph is not only very experienced in doing case-based research and in negotiating access to organizations, he is also extremely generous in offering help and assistance to young researchers. In my case he not only negotiated access to the German publishing house, he actually interrupted his holiday in Germany to introduce me personally to the director of the publishing house’s international division and to help negotiate access to the firms’ foreign subsidiaries.

Special thanks also go to the employees of the German publishing house who agreed to participate in my research. Their explanations and recollections of the

Internationalization Decisions

ii

decision-making processes surrounding their organization’s international expansion resulted in invaluable illustrations of the main argument in this book.

I also want to express my sincere gratitude to all my (former) colleagues at the Department of International Business and Management of the University of Groningen for the extremely collegial and supportive work environment they provided. I also want to thank my friends, both at home and abroad, for providing the much-needed occasional distractions from my work, and for making sure that my almost consistent mental preoccupation with my Ph.D. project—a common symptom among Ph.D. students—did not result in social isolation.

Finally, I want to deeply thank my parents and sister for all the moral support they offered during these eventful five years, and for their unfaltering belief that I would, some day, finish this dissertation. My parents’ house proved to be the perfect refuge during stressful times, a place where I was always welcome, as well as the perfect starting point for a run (a sentiment which was greatly enhanced by my perceived lack of trees in Groningen). Thank you!

Jasper Hotho Copenhagen, August 2009

Table of contents

CHAPTER 1

INTRODUCTION..............................................................................................................7

1.1 An introduction to internationalization processes .....................................................7

1.2 Theories on internationalization .................................................................................9

1.3 Internationalization process theory...........................................................................13

1.4 Outline ........................................................................................................................18

CHAPTER 2

RETHINKING INTERNATIONALIZATION PROCESS THEORY —AN INTRODUCTION TO FAMILIARITY PERCEPTIONS.....................................21

2.1 Introduction ...............................................................................................................21

2.2 The behavioural foundations of the internationalization process model ...............22

2.3 A critique of the theoretical foundations of internationalization process theory...27

2.4 Suggestions from the literature on organizational decision-making.......................29

2.5 Rethinking internationalization process theory: familiarity perceptions as a

unifying concept ........................................................................................................32

2.6 A summary and some concluding remarks...............................................................35

CHAPTER 3

A MEASURE OF COMPARATIVE INSTITUTIONAL DISTANCE ............................39

3.1 Introduction................................................................................................................39

3.2 Varieties of institutionalism and institutional distance............................................41


iv

3.3 Methodology ..............................................................................................................50

3.4 Results .........................................................................................................................59

3.5 Discussion...................................................................................................................62

3.6 A measure of comparative institutional distance .....................................................63

3.7 Conclusion..................................................................................................................64

CHAPTER 4

THE FAMILIARITY DIMENSION OF PSYCHIC DISTANCE—OR, WHY HISTORICAL TIES AFFECT THE LOCATION OF FOREIGN INVESTMENT ..........67

4.1 Introduction ...............................................................................................................67

4.2 Psychic distance and the location of foreign investment .........................................69

4.3 Data and methods ......................................................................................................75

4.4 Results .........................................................................................................................79

4.5 Discussion and conclusion ........................................................................................84

CHAPTER 5

INTERNATIONALIZATION AND MNE RESPONSES TO UNLEARNING —THE CASE OF A GERMAN PUBLISHING HOUSE ................................................89

5.1 Introduction ...............................................................................................................89

5.2 Knowledge, uncertainty, and familiarity perceptions ..............................................90

5.3 The case of a German publishing house ...................................................................92

5.4 Findings ......................................................................................................................96

5.5 Discussion.................................................................................................................111

5.6 Conclusion................................................................................................................118

Table of Contents

v

CHAPTER 6

CONCLUSIONS AND RECOMMENDATIONS FOR FUTURE RESEARCH..........121

6.1 Introduction..............................................................................................................121

6.2 Summary of the findings..........................................................................................122

6.3 Foreign market familiarity: implications for internationalization

process models .........................................................................................................124

6.4 Research limitations .................................................................................................126

6.5 Directions for future research..................................................................................127

APPENDIX A: INSTITUTIONAL INDICATORS

AND CORRESPONDING QUESTIONS......................................................................131

APPENDIX B: INSTITUTIONAL DISTANCES

(AVERAGED SQUARED EUCLIDEAN DISTANCE).................................................133

APPENDIX C: INSTITUTIONAL DISTANCES

(EUCLIDEAN DISTANCE)...........................................................................................137

APPENDIX D: DESCRIPTIVES AND GRAVITY ESTIMATIONS

FOR 1984–88, 1989–93, AND 1994–98 ........................................................................141

APPENDIX E: STRUCTURE OF INTERVIEW GUIDE AND

TOPICS COVERED DURING INTERVIEWS .............................................................145

BIBLIOGRAPHY ............................................................................................................147

NEDERLANDSE SAMENVATTING............................................................................169


vi

Chapter 1

Introduction

“Even though there is now a considerable and growing body of research on various aspects of internationalization, there remains limited development and questioning

of the basic concepts that underpin internationalization as a process. Indeed, one could argue that we have barely scratched this surface.”

—Liesch and colleagues (2002: 26)

1.1 An introduction to internationalization processes This book deals with a fundamental issue in International Business studies, namely the processes by which firms develop their international activities. In the field of International Business, this topic was first addressed well over four decades ago; most prominently by a group of Swedish scholars at Uppsala university. Ever since, the contexts in which firms operate have changed tremendously. There have been both anticipated and unanticipated shifts in geopolitical power, and bold steps have been taken toward greater social, political, and economic integration. At the same time, we’ve witnessed a decline in barriers to trade, a worldwide increase in wealth (often combined with rising inequality), and vast technological developments in information technology. Such changes, it has been argued, have forced firms to considerably alter their behaviour in order to survive in today’s global environment (Axinn and Matthyssens, 2002).

What has not changed, however, are the basic challenges faced by firms deciding to cross borders. Inexperienced firms lack an in-depth understanding of the foreign markets they seek to enter, such as of local business and market conditions, and firms are often unacquainted with the local contexts of foreign markets. In addition, newly internationalizing firms lack experience in setting up and organizing their activities abroad, which is far more complex than the day-to-day management of domestic operations.


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The central notion in behavioural models of internationalization processes is that the uncertainty caused by a lack of knowledge and experience must influence the decisions firms take, such as which markets to enter and whether to do so by exporting or perhaps through the establishment of a local subsidiary. The main reasoning of behavioural internationalization scholars is that decision-makers deal with uncertainty both through incremental decision making and by learning ‘on the go’ through experience (e.g. Wiedersheim-Paul, 1972; Johanson and Wiedersheim-Paul, 1975; Johanson and Vahlne, 1977). This, it is argued, is reflected in the internationalization patterns of firms. In terms of market selection, firms are expected to prefer markets which are relatively similar to the home market, as such markets are more easily understood. In terms of a firm’s involvement in foreign markets, it is argued that firms prefer to ‘test the water’, such as through exporting or a local repre-sentative, before gradually increasing their direct involvement in a foreign market.

Yet both empirical and anecdotal evidence suggest that firms often do enter foreign markets through relatively committed modes of entry, such as through the establishment of a local subsidiary. For example, in Brouthers’ sample of 178 foreign market entries (Brouthers, 2002), 61% of the entries were wholly owned subsidiaries and 26% joint ventures, while only 13% consisted of foreign entries through licensing and exporting. Even among inexperienced small and medium sized enterprises (SMEs), the establishment of wholly-owned subsidiaries is not uncommon (Nakos and Brouthers, 2002; Pinho, 2007; Rasheed, 2005). In fact, research has identified a group of SMEs—commonly known as international new ventures or ‘born-globals’—which are characterized by rapid international involvement even at inception (Oviatt and McDougall, 1994; Shrader, Oviatt, and McDougall, 2000).

Similarly, the notion that firms prefer to enter markets that are more similar to the home market has received mixed support. For example, on the one hand both Grosse and Goldberg (1991) and Grosse and Treviño (1996) find that firms originating from culturally more different countries tend to be less directly involved in the United States, in terms of both assets and offices (Grosse and Goldberg, 1991) and foreign investment (Grosse and Treviño, 1996). Yet neither Engwall and Wallenstål (1990), Benito and Gripsrud (1992), Mitra and Golder (2002) nor Ellis (2007) find support for the idea that firms gradually expand into countries which are culturally increasingly more different. At the very least, such conflicting findings should give rise to healthy scepticism regarding the importance attached to country differences in explaining foreign market selection.

These examples barely do justice to the vast body of International Business (IB) literature on internationalization, but they are illustrative of the state of play: While our understanding of internationalization processes has greatly improved, for example in terms of our understanding of the different components of experiential inter-nationalization knowledge (Eriksson, Johanson, Majkgård and Sharma, 1997; 2000) or in terms of our understanding of the importance of business networks (e.g. Johanson

Chapter 1: Introduction

9

and Mattson, 1988; Blankenburg Holm, Eriksson, and Johanson, 1996; Leonidou, Katsikeas, and Hadjimarcou, 2002), empirical studies on the basic drivers of internationalization processes continue to produce conflicting results. Such conflicting findings indicate that despite the steady increase in research on internationalization over the last two decades, the exact factors affecting human decision-making in the context of internationalization are still not fully understood.

What is more, as the quotation at the beginning of this introduction illustrates, theoretical progress has been limited. The dominant theory explaining the processes by which firms internationalize—the learning-based ‘Uppsala’ or ‘Nordic’ model—has remained virtually unchanged. This, to some extent, is testimony to the relative robustness of the model, and to the appeal of the behavioural perspective it adopts to understanding internationalization as a process. Yet while the key assumptions of the Uppsala model correspond closely to early scholarly work on organizational learning and decision-making, such as Cyert and March (1963) and Aharoni (1966), the assumptions of the model have not changed following more recent insight into both organizational learning and human decision-making (Forsgren, 2002). The objective set out here is to improve on the state of play by reconsidering, both theoretically and empirically, some of the basic factors affecting internationalization decisions; in particular the importance of country differences and actual knowledge.

The central thesis of this book is simple: Apart from the attractiveness of foreign markets in terms of factors such as size, distance, entry barriers and market potential, the internationalization process of firms is mainly driven by the extent to which foreign markets are perceived as familiar, which reduces the risk and uncertainty associated with foreign market commitments. This thesis builds on two related assumptions underlying human decision-making, namely that decisions are based on both actual knowledge and the subjective beliefs which decision-makers hold to be true (Simon, 1947; 1991), and that both substantiated knowledge and unsubstantiated beliefs reduce the uncertainty which decision-makers experience. To understand how this thesis advances the explanatory power of internationalization models, some explication of current theories on internationalization—and internationalization process theory in particular—is essential. Hence, apart from providing an outline of the remainder of this book, I will use this chapter to provide a brief introduction to IB theories on internationalization, and to some of the core concepts in this book.

1.2 Theories on internationalization

Theories on internationalization—understood as “the process of increasing involvement in international operations” (Welch and Luostarinen, 1988: 36)—can be divided and classified along several lines. For example, theories on international-ization can be divided into theories which seek to explain the degree of market


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commitment of the firm—in terms of the commitment of resources and/or the selected mode of entry—and those which seek to explain the selection of particular foreign markets over other markets. A second division is between theoretical perspectives which are rooted in economics, and behavioural theoretical perspectives on internationalization. Table 1.1 presents a classification of theories on internation-alization in International Business along these lines. Degree of market commitment Over the past two decades, transaction cost theory (TCT) (Williamson, 1975; 1981) has “served as the overriding perspective for theorizing entry mode choice and, accordingly, transaction-cost-related covariates have been recognized as major determinants of entry mode decision” (Zhao, Luo and Suh, 2004: 525). From a transaction cost perspective, entry mode selection is approached as an issue of governance, and entry mode selection is largely treated as a relatively isolated economic decision. Firms are expected to select the entry mode with the lowest transaction costs, given a particular degree of asset specificity, and considering the combined effect of asset specificity and external uncertainty, internal uncertainty, and the potential for free riding by potential business partners (Anderson and Gatignon, 1986). Meta-analysis has established empirical support for the basic predictions of the TCT perspective on entry mode selection (Zhao, Luo and Suh, 2004), in particular when only the crude dichotomous trade-off between markets (such as exporting) and hierarchies (equity-based entry modes) is considered. Yet the TCT perspective is not without limitations (see for example Ghoshal and Moran, 1996) and IB scholars increasingly share the view that “transaction cost thinking […] could be enriched by coopting variables and concepts from other disciplines with a richer tradition of in-depth analysis of organizational functioning” (Verbeke, 2003: 499).

Closely related to transaction-cost-based perspectives on internationalization—in that the form of an MNEs involvement in foreign markets is similarly explained by market imperfections—is internalization theory, as developed in the work of Buckley and Casson (1976; 1998) and Rugman (1981). Internalization theory views the MNE as a bundle of resources and activities which can either be internalized and exploited or externalized, depending on costs and the benefits generated by imperfections in external markets. Entry mode selection and international expansion is largely framed as an issue of where to draw the border of the MNE; which is dependent on whether the costs and benefits of exploiting proprietary knowledge and controlling the firm’s activities through firm-based entry modes outweigh the benefits and costs of exporting, or of licensing the firm’s knowledge and activities to local partners.


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A second related perspective is the knowledge-based evolutionary perspective of the multinational corporation, which views the multinational enterprise (MNE) as the superior vehicle to transfer tacit knowledge across borders (Kogut and Zander, 1993; Tallman, 2003). As such, foreign expansion is explained by the competitive capabilities of a firm to successfully create, replicate, and transfer knowledge abroad (Kogut and Zander, 1993), and firms with a strong technological base and a rich knowledge structure are therefore predicted to expand internationally through start-ups rather than through acquisitions (Barkema and Vermeulen, 1998). Compared to internalization and transaction cost perspectives on entry and establishment mode selection, Kogut and Zander’s work emphasizes that alternative modes are evaluated in terms of differences in their potential for value creation, rather than in terms of differences in transaction costs.

The various innovation models of internationalization (e.g. Bilkey and Tesar, 1977; Cavusgil, Bilkey and Tesar, 1979; Reid, 1981) present a different view on the degree of foreign involvement, in that the development of export behaviour is represented as an organizational innovation process. The various models describe the early stages of export behaviour in terms of several sequential export stages. For example, Reid (1981) distinguishes between five consecutive stages, ranging from export awareness—in which the need or opportunities for exporting is recognized—to adoption or rejection of exporting. The innovation models are highly intuitive, yet the

Table 1.1: Classification of theories on internationalization in International Business

Theoretical scope

Theoretical foundations

Market commitment Market commitment & location choice

Location choice

Economics-based theories

Transaction cost theory Internalization theory Knowledge-based theory of the MNE

Eclectic OLI paradigm Life cycle model

Behavioural theories

Innovation models Internationalization process theory


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various models also suffer from their descriptive nature and possess limited explanatory power. Although most authors at a later stage invested in further explaining why firms move from one stage to the next (Andersen, 1993), these models generally suffer from a “lack of proper theory” (Andersen, 1993: 217). In addition, the question on what basis firms select some foreign markets over others is largely left unanswered. Location choice Emphasizing such factors as local demand and transportation costs, factor endowment, and local governance policies, the location of foreign trade and investments has by nature been the domain of international economists. To these explanations, International Business adds factors which explain differences in location-choice between firms, mainly by emphasizing firm-level differences in the attractiveness of foreign markets, and differences in the costs MNEs incur when doing business abroad. These differences have been argued to stem from such characteristics as the country of origin (e.g. Henisz and Delios, 2001; Johanson and Vahlne, 1977; 1990), MNE strategy (Makino, Lau, and Yeh, 2002; Chung and Alcacer, 2002), and MNE experience (e.g. Davidson, 1980; Johanson and Vahlne, 1977; 1990). Apart from internationalization process theory, discussed in the next section, IB scholars have mainly relied on the work of John Dunning and, to a much lesser extent, Raymond Vernon to explain location choice.

Vernon’s product life-cycle model (Vernon, 1966) relates shifts in international trade and investment to shifts in local demand, and to shifting factor costs over the course of an industry’s product life cycle. As a product moves through the various stages of its life cycle, gradually moving from product development to product maturity, “concern about production cost […] take[s] the place of concern about product characteristics” (Vernon, 1966: 196). At the same time, Vernon argues, demand for the product may gradually spread to less-advanced economies. This gradually causes the location of production to shift from the country in which the product was developed (in Vernon’s work, the United States) to less-advanced countries with lower production costs, where firms from the home country eventually face competition from local entrepreneurs. Over the course of a product’s life cycle, this gradually turns the country of origin of a particular product from a net exporter into a net importer.

The second and more prominent theoretical perspective in International Business on the location of MNE activity is the eclectic paradigm developed in the work of John Dunning (e.g. Dunning, 1958; 1988). Dunning explains the activity of firms abroad by arguing that foreign investment is a function of the competitive advantages which encourage firms to internationalize (O), of the competitive advantages of some locations over others (L), and of the extent to which a firm


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decides to internalise its foreign activities (I). The extent and location of a firm’s activities are largely explained by Williamsonian and International Economics-based arguments respectively. Although more of a theoretical framework than a theory in itself, the eclectic ‘OLI’ paradigm is one of the few IB perspectives on MNE activity which seeks to explain both the extent and the location of foreign investment and international production. However, due to the generality of the eclectic paradigm (Dunning, 1988), and as Dunning’s work focuses primarily on explaining the investment pattern of groups of firms at either the country or industry level (Dunning, 2001), the eclectic paradigm has limited power in explaining the internationalization behaviour of individual firms.

1.3 Internationalization process theory

In contrast to the theoretical perspectives on internationalization discussed above, internationalization process theory is concerned with resource commitment, market selection and sequence. It is less concerned with the question why firms internationalize, and instead focuses on how, where, and when. Originating in the work of Swedish scholars in the 1960s and 70s, (e.g. Carlson, 1966; Wiedersheim-Paul, 1972; Johanson and Wiedersheim-Paul, 1975) internationalization process theory adopts a behavioural approach to internationalization, rooted in the work of Cyert and March (1963), Aharoni (1966) and Penrose (1957). It is assumed that internationalization does not result from the optimal allocation of resources based on a careful comparison of alternative foreign markets and modes of entry. Rather, internationalization process theory relates market selection, market commitment and sequence to the uncertainty and risks internationalizing firms experience due to a lack of information and experiential knowledge, by positing that firms primarily deal with risk and uncertainty through incremental decision-making and by learning about foreign markets and international operations.

Internationalization process theory applies this notion to address two distinct patterns: the degree of market and resource commitment within foreign markets, and foreign market selection. Based on the observation that Swedish firms often develop their operations abroad incrementally rather than treating their foreign operations as one-off investments (e.g., Wiedersheim-Paul, 1972; Johanson and Wiedersheim-Paul, 1975), internationalization process theorists predicted that what initially defers the commitment of resources to a foreign market, is a lack of local-market knowledge. As firms accumulate local-market knowledge through experience, their involvement in the foreign market is expected to increase in terms of both the mode of operation and the commitment of resources (Johanson and Vahlne, 1977, 1990); a process which is labelled the ‘establishment chain’ (Johanson and Wiedersheim-Paul, 1975). In a sense, internationalization process theory thus characterizes the internationalization process


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within foreign markets as a gradual ‘learning through experience’ process (O’Grady and Lane, 1996).

Second, internationalization process theory predicts that in addition to factors such as market size and market potential, firms initially select foreign markets on the basis of their psychological closeness to the home market (Johanson and Wiedersheim-Paul, 1975; Johanson and Vahlne, 1977). The degree of psychological or ‘psychic’ distance between the home and the foreign market is strongly related to country differences, such as differences in language, culture, and political system, which are assumed to disturb the flow of information. As similar countries are therefore assumed to be easier to understand, internationalization process theory predicts that firms experience less uncertainty towards these markets, and that firms enter markets which are more similar, before psychically more distant—less similar—markets are entered (Johanson and Vahlne, 1990). As such, the notion of psychic distance is employed as the cognitive link between foreign markets and the uncertainty decision makers experience towards these markets. Taken together, internationalization is characterized by the gradual expansion into psychically more distant markets, combined with a gradually deepening involvement in those markets in which the firm is already active—much, it has been noted, like the rings which appear on the water when throwing a pebble in a pond.

The value of the behavioural perspective internationalization process theory employs in understanding the dynamics of internationalization is evident. Yet at least two observations support a critical review of the basic assumptions of internationalization process theory—in particular the idea that firms eschew foreign countries that are dissimilar from the home country, and the idea that actual local market-knowledge is the main driver of internationalization decisions. First, empirical support for the basic predictions of the internationalization process model has been mixed. Second, the psychic distance concept, in particular the association of psychic distance with cultural differences, has also been criticized on conceptual grounds.

Empirical support Part of the charm of internationalization process theory is in its intuitive appeal. However, empirical support for some of the basic predictions of internationalization process theory is not undisputed; not even to the sympathetic observer (e.g. Björkman and Forsgren, 2000).1

For example, while psychic distance is a widely accepted concept in the literature on export behaviour (Stöttinger and Schlegelmilch, 1998), empirical studies on the

1 The studies considered here are empirical studies which were conducted relatively inde-pendent of the line of research which lead to the development of the internationalization process model.


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effect of psychic distance on export activities are inconclusive. Dow (2000) for example, who uses a panel of experts to develop a psychic distance scale, finds that psychic distance is a highly significant predictor of early export market selection for his sample of Australian manufacturing firms. Yet Stöttinger and Schlegelmilch (1998), using subjective country distance scales, find no effect of psychic distance on the development of export activities of the firms in their sample. A related study by Klein and Roth (1989) on the export channel structure of 900 Canadian exporters instead suggests that the effect of psychic distance is dependent on the extent to which firms make use of specialised assets: While Klein and Roth find that perceived differences have a significant effect on the degree of forward integration of firms with low asset specificity (i.e. firms which make no extensive use of specialised assets), for firms high in asset specificity the coefficient of perceived country differences was not significant. A close look at the results of a study by Dow and Karunaratna (2006) instead raises the question whether all country differences are equally relevant in explaining the export behaviour of firms. Their analysis focuses on the effect of various potential psychic distance ‘stimuli’ on the trade intensity between 38 countries. The results show that while the coefficients for differences in the level of industrial development, the level of education, and religion are both negative and significant, the coefficients for differences in culture and common language, among others, are not significant.

Studies which instead focus on the effect of psychic distance and country differences on the location of foreign investments, tend to make use of absolute country differences such as cultural distance (Kogut and Singh, 1988) rather than subjective distance measures. As with studies on export behaviour, empirical studies on the effect of country differences on investment location are similarly inconclusive. Often cited studies by Davidson (1980) and Grosse and Treviño (1996) for example, appear to support the notion that firms prefer investments into markets which are more similar to the home country. Davidson (1980), focusing on foreign investments by 180 large U.S. firms, finds that internationally inexperienced firms in particular have a preference for investing in more similar foreign markets. Grosse and Treviño (1996) find that a similar pattern appears to hold for firms investing in the United States. In their study, both cultural and geographical distance were negatively related to the amount of foreign direct investment countries invest in the United States. However, a study by Benito and Gripsrud (1992) illustrates that support for the effect of country differences on investment location is not universal. Focusing on investment decisions by Norwegian firms, Benito and Gripsrud (1992) find no support for the idea that the sequence in which foreign investments are made is related to the cultural distance from Norway.

Perhaps the best support for the idea that psychic distance affects location decisions is found in studies which focus on market selection—whether through exporting or otherwise—and the internationalization process of firms. For example, in


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his study on the internationalization process of Finnish firms, Luostarinen (1980) finds that the majority of Finnish firms (70%) tend to first enter those countries which are culturally most similar to Finland.2 Child, Ng, and Wong (2003) instead focus on the effect of psychic distance on the internationalization of Asian firms. The five Hong Kong firms which are the focus of their study initially internationalized into countries in South and Southeast Asia before other—predominantly Anglo-Saxon—countries were considered; thus lending additional support to internationalization process theory. Comparable effects are observed by Erramilli (1991) and Gripsrud and Benito (2005), who find that both U.S. service firms and U.K. retailers tend to only enter culturally more distant countries as international experience increases. Engwall and Wallenstål (1988) however, were unable to confirm a similar pattern—expansion from culturally close to culturally more distant countries—in their analysis of the internationalization process of Swedish banks.

Recent empirical studies focusing on ‘near-market’ effects challenge the importance attached to the degree of similarity between the home country and foreign markets. Mitra and Golder (2002) and Ellis (2007) for example, focusing on firms with a variety of Western origins and Chinese exporters respectively, find no support that the firms in their samples gradually expand into culturally more distant countries. In addition, Ellis (2007), using a panel of experts similar to Dow (2000) to construct psychic distance scales, found no direct effect of psychic distance on internation-alization sequence. Instead, both studies suggest that firms tend to enter markets that are similar to previously entered markets, rather than to the home market; a notion which builds on the idea that the probability of entering a foreign market is affected by a firm’s knowledge of previously entered markets (Mitra and Golder, 2002).

Empirical support is similarly mixed for the notion of an establishment chain; or the idea that a firm’s involvement in a foreign country develops incrementally due to a lack of local knowledge and experience. Support for this notion has mainly come from Nordic scholars.3 For example, while Engwall and Wallenstål (1988) found no support for the idea that Swedish banks gradually internationalize into culturally more distant countries, they did find that local international commitments by the banks in their sample tended to gradually increase over time. Pedersen and Petersen (1998), analyzing the foreign resource commitments of 165 Danish firms, also found support for the idea of gradually increasing foreign resource commitments. In addition, they argue that the internationalization of any firm occurs incrementally, and that it is

2 In Luostarinen (1980), cultural distance consists of a combination of the level of economic development and education, and common language. Luostarinen also demonstrates that Finnish firms tend to enter foreign markets more committedly—such as through investment-based production and marketing operations—if the foreign country shares a common language. Due to issues of multicollinearity however, the level of education and economic development were not considered in this analysis (Luostarinen, 1980: 155-156). 3 For an overview of research by Nordic scholars on the validity of the internationalization model, see for example Björkman and Forsgren (2000).


17

merely a matter of the pace at which firms internationalize, rather than a question of whether internationalization occurs gradually or instantaneously. Support for the notion of gradually increasing commitments to foreign markets is not restricted to Nordic research. For example, in his earlier-mentioned study on foreign investment location by U.S. firms, Davidson (1980) also found support for the idea that local experience tends to increase the propensity of firms for further investments in a particular country.

However, the notion that firms abstain from foreign market commitments in the absence of local knowledge and actual experience with local markets has also been challenged. Focusing on Japanese market entries by Swedish firms, Hedlund and Kverneland (1985) for example found that at least half of the firms in their sample adopted a more direct approach to expansion of their Japanese activities than would be expected. Similarly, Turnbull (1987) found that the international expansion of the U.K. firms in his sample did not follow an evolutionary path. Studies by Sullivan and Bauerschmidt (1990), Millington and Bayliss (1990), Erramilli and Rao (1990), and Björkman and Eklund (1996) were also unable to confirm the incremental pattern of increasing market involvement predicted by internationalization process theory. Furthermore, as noted earlier, the notion of incrementalism also runs counter to the common empirical observation that firms in fact regularly enter foreign markets through relatively committed modes of entry, such as through wholly-owned subsidiaries (see e.g. Brouthers, 2002). And criticism of the idea of incremental internationalization has only intensified with the notion of rapidly internationalizing ‘born-globals’ or international new ventures and the advent of the ‘new economy’ (e.g., Oviatt and McDougall, 1994; Shrader, Oviatt, and McDougall, 2000; Oviatt and McDougall, 2005).4 In all, in a review of Nordic studies on the internationalization process of firms, Björkman and Forsgren (2000) describe empirical support for the establishment chain as “considerable, although not undisputed” (2000: 11). The conceptualization of psychic distance The key concept of psychic distance has also been the frequent subject of conceptual discussions. Following the widespread acceptance of psychic distance as a construct related to “differences in language, education, business practices, culture, and industrial development” (Johanson and Vahlne, 1977: 24), early studies on the effect of psychic distance focused primarily on cultural differences. The association of psychic distance with country differences was strengthened both by the growing conviction that cultural and psychic distance are closely related concepts (Harzing,

4 For an overview of environmental changes which pose a challenge to traditional inter-nationalization theories, see Axinn and Matthyssens (2002); and, for a response to similar concerns, see Vahlne and Johanson (2002).


18

2003), and by the availability of simple measures of cultural distance. For example, in their seminal paper on the mechanism of internationalization, Johanson and Vahlne (1990) explain that the internationalization model “predicts, taking only psychic distance into account, that firms will start by invading “neighbouring” (in the cultural sense) markets” (1990: 17). Similarly, in their study on the influence of cultural distance on entry modes, Kogut and Singh (1988: 430) claim that “[c]ultural distance is, in most respects, similar to the “psychic distance” used by the Uppsala school”. Their study popularized the use of a simple measure of cultural distance based on the Hofstede indices (Hofstede, 1980), which facilitated the interchangeable use of cultural and psychic distance.

In response to growing convergence between psychic and cultural distance, from the mid-1990s onwards several authors suggested to broaden the measurement of psychic distance. Some suggested to include other factors relating to country differences, such as differences in language, and legal and administrative differences (Harzing, 2003), or differences in industry structure and the competitive environment (O’Grady and Lane, 1996). In a recent study, Brewer (2007) instead proposes to extend the measurement of psychic distance with indicators other than country differences alone. Others argue for psychic distance measures which measure perceived country differences (O’Grady and Lane, 1996; Evans et al., 2000; Dow, 2000; Harzing, 2003). This has resulted in psychic distance measures based on expert panels (Nordström, 1991; Dow, 2000), psychographic instruments (O’Grady and Lane, 1996), and large-scale questionnaires (Stöttinger and Schlegelmilch, 1998).

Yet despite much debate over how psychic distance is to be operationalized, actual theoretical development of the psychic distance construct has been surprisingly limited (Liesch et al., 2002; Dow and Karunaratna, 2006). This is problematic, as the lack of consistent empirical support for the psychic distance construct, noted in the previous section, may well result from a misconception about what causes decision makers to perceive some countries as psychologically more distant than others.

1.4 Outline

The issues raised above provide strong motivation for a critical assessment of two key assumptions on which internationalization process theory builds, namely the idea that firms eschew foreign countries that are dissimilar from the home country, and the idea that actual local-market knowledge is the main driver of internationalization decisions. In this book the validity of these assumptions is contested conceptually (Chapter 2), and assessed both through a quantitative analysis of the location of foreign investment (Chapter 4) and through an in-depth case study of the inter-nationalization process of a German publishing house (Chapter 5). These studies are strongly complementary. Chapter 4 assesses the effects of familiarity perceptions on internationalization decisions through objective measures by focusing on bundles of


19

internationalization decisions, namely the location of foreign direct investment. Chapter 5 instead examines the effects of subjective accounts of familiarity perceptions on internationalization decisions at the firm level. Taken together, the chapters in this book develop the notion that the perception of familiarity is an important yet much overlooked driver of internationalization decisions; a notion which, though simple, may help explain the observed heterogeneity in internationalization patterns. Below I provide a brief outline of the content of each chapter.

The central thesis of this book largely builds on the same behavioural foundations as internationalization process theory, but present a different explanation of what drives internationalization decisions. The purpose of Chapter 2 is to clarify the underlying reasons for this difference. To that end, Chapter 2 presents a conceptual critique of the two assumptions of internationalization process theory discussed above. It is argued that internationalization process theory overemphasizes the importance of knowledge in internationalization decisions, that the proposed link between country differences and uncertainty is underdeveloped and unconvincing, and that internationalization process theory is inconsistent in what is at the source of the uncertainty associated with internationalization decisions. Building on two suggestions from the literature on organizational decision-making, the notion of familiarity perceptions is then proposed as a central concept in understanding internationalization decisions, and several lines of research are developed which are addressed in the subsequent chapters.

In anticipation of the empirical study in Chapter 4, which focuses on the effects of historical ties and country differences on the location of foreign investment, Chapter 3 addresses the lack of an indicator of intrinsic institutional country differences. Recently, much progress has been made in the operationalization of potential country level psychic distance stimuli (Dow and Karunaratna, 2006; Brewer, 2007), such as differences in industrial development, political ideology and religion. What has been missing from most analyses however is a consideration of the effect of institutional differences. This, it is argued in Chapter 3, can be attributed to the lack of an appropriate institutional distance indicator. Existing indicators of institutional differences either capture differences in institutional quality and effectiveness (for examples see Delios and Beamish, 1999; Meyer, 2001; Wan and Hoskisson, 2003), or differences in the regulative, normative and cultural-cognitive elements which affect organizational behaviour in a particular setting (Kostova, 1997; Busenitz et al., 2000; Kostova and Roth, 2002). What is still lacking however is an indicator of intrinsic institutional country differences; or, in other words, an indicator which captures the type of differences in socio-economic organization which can be found between, for example, the advanced economies of Sweden, the United States, and the Netherlands.

In Chapter 3 this issue is addressed through the development and validation of an institutional distance indicator which builds on comparative institutional thought;


20

in particular the work of Richard Whitley on comparative business systems (Whitley, 1992; 1998; 1999). As such, the study in Chapter 3 also presents an opportunity to empirically assess whether there is any quantitative support for the distinctiveness of the business system types that make up the business systems framework. While the business systems typology proposed by Whitley is applied widely to characterize capitalist market economies, Whitley’s typology emerged from detailed but relatively particularistic socio-economic accounts and comparisons of both Asian and European market economies. The cluster analysis in Chapter 3 offers the first systematic analysis of whether similar coherent socio-economic configurations emerge when a wider set of countries is considered.

The measure of comparative institutional distance developed in Chapter 3 is subsequently applied in Chapter 4, in which the effect of the perception of familiarity on location decisions is explored. To that aim, Chapter 4 examines the extent to which both country differences and historical ties—a variable associated with the perception of familiarity—affect the location of foreign direct investment originating from the United Kingdom, France, the Netherlands, and Germany between 1984 and 2003. Building on the idea that the perceived understanding of foreign markets depends both on actual knowledge and market information as well as on the unsubstantiated beliefs, assumptions, and generalizations that are held to be true, the perception of foreign market familiarity is put forward as an important yet overlooked dimension of psychic distance perceptions.

While the quantitative study in Chapter 4 explores the effect of familiarity perceptions on location choice, in Chapter 5 an embedded case study is employed to explore the effect of familiarity perceptions on the development of local market commitments. The internationalization process of the German publishing house which is the subject of the case study in Chapter 5 is characterized by a string of high-commitment entries into the markets of Central Eastern Europe. It therefore is a typical case where a firm’s involvement in new foreign markets does not progress as gradually as predicted by internationalization process theory. In addition, the firm experienced negative cultural learning processes in several markets. The organizational responses differed widely, from attempted withdrawal to the persistence of high-commitment entry-modes. Chapter 5 focuses on the reasons behind these alternative responses.

The final chapter of this book provides a brief overview of the findings, and ties together the conclusions that can be drawn from the separate studies. The concluding chapter highlights that the notion of foreign market familiarity may have important implications for behavioural explanations of internationalization processes. More specifically, it is implied that incorporating the notion of familiarity perceptions into internationalization models has implications for the internationalization patterns which can be expected from a behavioural standpoint. This provides fertile ground for future research, for which several interesting directions are suggested.

Chapter 2

Rethinking internationalization process theory—An introduction to familiarity perceptions 2.1 Introduction

Internationalization process theory offers a behavioural model of international firm behaviour. This implies that instead of assuming that internationalizing firms have a perfect understanding of foreign contexts and operations, internationalization process theory depicts the firm as a learning entity which deals with a lack of knowledge and with high uncertainty through incremental decision-making. As such, the inter-nationalization process model links “the development of knowledge about foreign markets and operations” to the “increasing commitment of resources to foreign markets” (Johanson and Vahlne, 1990: 11).

The assumptions of the internationalization process model, which are rooted in the behavioural theory of the firm and the theory of the growth of the firm, strongly affect the predicted internationalization process of firms: that of gradually deepening involvement in countries which are increasingly different from the firm’s home country. The central thesis of this book builds on the same behavioural foundations, but presents a different explanation of what drives internationalization decisions. In this chapter I intend to clarify the conceptual foundations for this difference.

This chapter is structured as follows. In section 2.2, I briefly introduce the behavioural foundations of the internationalization process model. Readers familiar with the model’s behavioural underpinnings, in particular the behavioural theory of the firm and the theory of the growth of the firm, may want to jump directly to


22

section 2.3. There, I critically review the key assumptions of the internationalization process model regarding what drives internationalization decisions. Two conceptual problems of the internationalization process model are highlighted: the primacy of objective knowledge and the link between uncertainty and country differences. Section 2.4 presents two notions from the literature on organizational decision-making which internationalization process theory overlooks, but which are of use in addressing these problems. Section 2.5 subsequently discusses how these suggestions can be integrated in the internationalization process model through the notion of familiarity perceptions.

2.2 The behavioural foundations of the internationalization process model

The internationalization process model explicitly builds on two theories of organi-zational behaviour: the behavioural theory of the firm (in particular Cyert and March, 1963) and the theory of the growth of the firm developed by Edith Penrose (1959). The behavioural theory of the firm deals with organizational decision-making, while the theory of the growth of the firm discusses the factors that propagate organizational growth and the factors which limit the rate at which organizations grow. These themes both feature prominently in the internationalization process model. Both theories were developed in response to the neoclassical view of the firm as a rational and optimizing entity with perfect knowledge of all available alternatives and their consequences (in other words, their costs and benefits). And despite obvious differences between the two theories, both start from the premise that in order to understand economic behaviour, we need to focus on the firm’s internal processes. In this section I will briefly discuss each theory, highlight the elements of each on which the internationalization model builds, and discuss how these affect the internatio-nalization pattern predicted by internationalization process theorists

2.2.1 The behavioural theory of the firm and internationalization process theory

Together with Simon’s (1945) Administrative Behavior and March and Simon’s (1958) Organizations, A Behavioral Theory of the Firm (Cyert and March, 1963) is one of the foundational works of the Carnegie School. Together, these complementary works formed the starting-point for the development of the behavioural theory of the firm (Argote and Greve, 2007). But while almost all ideas of the Carnegie school eventually influenced the development of the internationalization process model, as noted by Madsen (2005) most internationalization process research—including Johanson and Vahlne (1977)—refers to Cyert and March (1963). Here, I will therefore focus on their contribution.

Similar to Administrative Behavior (Simon, 1945) and Organizations (March and Simon, 1958), Cyert and March’s A Behavioral Theory of the Firm deals first and

Chapter 2: Rethinking Internationalization Process Theory

23

foremost with the reality of organizational decision-making. It starts from the premise that,

“in order to understand contemporary economic decision making, we need to supplement the study of market factors with an examination of the internal operation of the firm—to study the effects of organizational structure and conventional practice on the development of goals, the formation of expectations and the execution of choices.” (Cyert and March, 1963: 1)

The theoretical underpinning of A Behavioural Theory of the Firm consists of four major concepts: the quasi-resolution of conflict, the notion of uncertainty avoidance, problemistic search, and organizational learning. In addition, the notion of bounded rationality is very much implicit. The internationalization process model explicitly builds on two of these components. The first is the notion of uncertainty avoidance, and the second the notion of problemistic search. In addition, the internationalization process model explicitly makes use of the notion of loose-coupling, which is related to the quasi-resolution of conflict. The notion of learning in the internationalization process model—with its strong emphasis on experiential knowledge—instead shows more similarities with learning and knowledge as discussed in Penrose’s The Theory of the Growth of the Firm than with Cyert and March’s notion of organizational learning.

The first key concept from A Behavioural Theory of the Firm on which inter-nationalization process theory builds is the notion of uncertainty avoidance. The notion that decision-makers avoid dealing with uncertainty by focusing on immediate problems and challenges is reflected in the emphasis of the internationalization process model on the incremental nature of internationalization decisions. Higher market commitments are associated with higher uncertainty. Therefore, it is expected that firms opt for relatively low commitments to foreign markets until the level of uncertainty is sufficiently reduced through local learning (e.g. Johanson and Vahlne, 1977).

The second concept from A Behavioural Theory of the Firm that is implicit in internationalization process theory is problemistic search; the notion that organi-zational solutions are problem-based, and that solutions to organizational problems are sought in the area of the problem rather than in a wider context. Johanson and Vahlne (1977: 29) assume that firms act reactively rather than proactively, in that internationalization “decisions are made in response to perceived problems and/or opportunities on the market”. In line with the notion of problemistic search, they subsequently assume that “solutions to market operations problems are searched for in the neighborhood of the problem symptoms, that is in the market activities” (1977: 29). In other words, when firms experience problems in their international operations, “decision alternatives […] will be related to the operations currently performed on the market” (1977: 29).


24

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25

The internationalization process model thus predicts that solutions are sought locally, and that “commitments to other markets are not explicitly taken into consideration” (1977: 26). What further enhances this notion is that “the firm is viewed as a loosely coupled system in which different actors in the firm have different interests and ideas concerning the development of the firm” (Johanson and Vahlne, 1990: 12).

Uncertainty avoidance and problemistic search manifest themselves in the predictions of the model in that internationalization decisions are made incrementally, and that firms will become more and more involved in the foreign markets in which they are active. In a sense, internationalization is therefore seen as relatively self-reinforcing. Firms strive to “keep risk-taking at a low level” (Johanson and Vahlne, 1977: 27), and problemistic search causes firms to prefer to “stick to a certain market and learn more about that market rather than to try new alternatives” (Forsgren, 2002: 261). This then results in more experiential knowledge, which reduces uncertainty, which in turn leads to additional market commitments. In other words, “the model expects that the internationalisation process, once it has started, will tend to proceed regardless of whether strategic decisions in that direction are made or not” (Johanson and Vahlne, 1990).

2.2.2 The theory of the growth of the firm and the nature of knowledge

Penrose’s (1959) Theory of the Growth of the Firm has been similarly influential on the development of internationalization process theory. Penrose explored the internal factors that cause firms to grow, and the internal factors that simultaneously limit a firm’s growth rate. Penrose’s contribution generated many important insights which later informed the development of the resource-based view of strategic management. Examples are the notion that excess resources and experience are important drivers of growth, and that scarcity of both resources and managerial capacity naturally limits the growth rate of firms.

The main element from The Theory of the Growth of the Firm which has influ-enced internationalization process theory is Penrose’s discussion of knowledge, in particular her distinction between objective knowledge and experiential knowledge. Penrose argues that knowledge can be acquired in two different ways: by means of studying and by learning from experience. The first leads to knowledge which is relatively objective in nature; it is not intimately connected with a person’s personal experience, but instead takes the nature of facts or statements which can be learned and passed on. In other words, it is relatively transmissible.

Learning through experience instead results in experiential knowledge. This is knowledge which due to its nature cannot be easily passed on, but can only be acquired by being personally involved in a certain activity. Johanson and Vahlne (1977) emphasize that experiential knowledge is particularly important to


26

internationalizing firms as, in contrast to domestic firms, foreign entrants initially lack such basic experiential knowledge. Local experience provides a “framework for perceiving and formulating opportunities” (1977: 28) and therefore is an important enabler of growth (cf. Penrose, 1959). At the same time, experiential knowledge can only be acquired by operating internationally, and therefore the lack of experiential knowledge also is a naturally inhibiting obstacle to international neophytes.

Johanson and Vahlne (1977) make a second distinction, which is based on know-ledge content: that between general knowledge and market-specific knowledge. While general knowledge has to do with “marketing methods and common characteristics of certain types of customers, irrespective of their geographic location” (1977: 28), market-specific knowledge refers to “knowledge about characteristics of the specific national market—its business climate, cultural patterns, structure of the market system, and, most importantly, characteristics of the individual customer firms and their personnel” (1977: 28). Johanson and Vahlne argue that while both general and market-specific knowledge are required to operate foreign operations, market-specific knowledge is mainly acquired through local experience. Knowledge of foreign operations—or international business knowledge (Eriksson, Johanson, Majkgård and Sharma, 1997)—on the other hand is considered to be relatively objective and transferable from one country to another, and therefore less strongly linked with local experience.

This distinction between transferable internationalization knowledge and non-transferable (but vital) experiential local market knowledge, has important implica-tions for the internationalization pattern predicted by internationalization process theory:

“Experiential knowledge is […] assumed to be the primary way of reducing market uncertainty. Thus, in a specific country, the firm can be expected to make stronger resource commitments incrementally as it gains experience from current activities in the market” (Johanson and Vahlne, 1990: 12; emphasis added).

In other words, within foreign markets, an increase in international activity is mainly explained by an increase in local experience. Instead, as local experience can only be transferred to other markets with great difficulty, expansion into subsequent foreign markets is almost entirely explained by international experience in general. Or, in the words of Johanson and Vahlne (1977: 28): “It is the diffusion of this general knowledge which facilitates lateral growth; that is, the establishment of technically similar activities in dissimilar business environments” (1977: 28).


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2.3 A critique of the theoretical foundations of internationalization process theory While internationalization process theory has been the frequent subject of empirical studies, the number of studies that critically review its theoretical underpinnings is limited. Two notable exceptions are Andersen (1993), who evaluates the strength of internationalization process theory as a theory, and Forsgren (2002), who critically reviews how learning is conceptualized in the internationalization process model.1 Instead, the following sections focus on two of the model’s key assumptions regarding what drives internationalization decisions; the primacy of true knowledge in decision making and the link between country differences and uncertainty.

Critique I: The primacy of knowledge The internationalization process model views a lack of knowledge as a key constraint to international growth. The reason is that knowledge is seen as a key requirement for commitment decisions: Knowledge and information of local problems and opportuni-ties initiate decision making (cf. problemistic search) and provide the firm with alternative solutions to such problems and opportunities (Johanson and Vahlne, 1977). In addition, “experiential knowledge is also assumed to be the primary way of reducing market uncertainty” (Johanson and Vahlne, 1990: 12), and a lack of local knowledge therefore inhibits larger resource commitments. A lack of knowledge is therefore seen as one of the main impediments to international expansion.

A key starting point of the central argument in this thesis is that from a behavioural perspective, the assumption that internationalization decisions are primarily based on knowledge alone is unnecessarily restrictive. Decisions are not merely based on the (often limited) information and knowledge available to decision makers, but also on the basis of beliefs: concepts such as assumptions, stereotypes, and prejudices which are held to be true, and which therefore may just as much affect decision making and the perception of uncertainty as does knowledge.

This point is widely recognized in epistemology—the strand of philosophy which deals with the nature of knowledge—where knowledge is often considered a subset of belief. Two criteria which are commonly used to set knowledge apart from other beliefs are that knowledge is true (i.e. a truth), and that believing it to be true is justi-fied, in the sense that a knower should have an adequate indication that a belief is true (Moser, 2002). In other words, while all knowledge can be considered true, beliefs may be true, and true beliefs only become knowledge once such beliefs are justified. The

1 The central gist of Forsgren’s argument is that as there are alternative mechanisms through

which market knowledge may be acquired, the importance of experiential learning is reduced. This may enable internationalization to take on a less incremental nature than predicted by internationalization process theory.


28

point here is that beliefs “do not have to be justified or true to affect decisions” (Markóczy, 1997: 1230); we merely need to believe something to be true. The implication for internationalization process theory is that if we assume that inter-nationalization decisions may be based on both actual knowledge and beliefs which are not necessarily justified nor true (but can be), then the mere lack of knowledge does not necessarily impede the internationalization process of firms.

Critique II: The link between uncertainty and country differences

In internationalization process theory, the concept psychic (or psychological) distance is used to explain why firms select some foreign markets over others. Psychic distance links the uncertainty experienced towards potential host countries to the extent to which local conditions resemble the home country. Thus, it is predicted that firms will initially select countries which are relatively similar to the home country before increasingly less similar (i.e. psychologically more distant) countries are entered. But while psychic distance is a potentially useful construct in explaining and understanding internationalization processes, there are several crucial conceptual problems with the suggested link between country differences and the uncertainty associated with internationalization decisions.

The first problem has to do with the concept of psychic distance itself. Johanson and Wiedersheim-Paul (1975: 208) define psychic distance as the “factors preventing or disturbing the flows of information between firm and market.” What follows are examples of factors which prevent the flow of information—essentially various forms of country differences, such as cultural and political differences—but there is hardly any further elaboration of the concept itself. For example, little attention is paid to exactly how psychic distance works as a perceptual filter, and how it affects the uncertainty associated with different foreign contexts. In fact, we could say that psychic distance is a concept which is mainly defined in term of its potential antecedents: country differences. As a result, it is unclear exactly how country differences affect psychic distance, and how psychic distance subsequently affects the uncertainty associated with location decisions. Johanson and Vahlne (1990) do allude to the ease with which foreign contexts can be understood, but essentially the link between psychic distance, uncertainty, and location decisions is underdeveloped.

A related issue is that due to considerable vagueness regarding the psychic distance concept, it is by no means certain that country differences are the main drivers of psychic distance. The lack of a clear conceptualization in effect pre-empts any discussion on the key factors affecting the psychic distance experienced towards foreign countries, which is reflected in the literature on psychic distance. For example, while there are several excellent recent studies that focus on whether or not there is a psychic distance effect (e.g. Dow, 2000; Ellis, 2007), whether we should work with perceived or objective country differences (Dow, 2000; Evans, Treadgold, and


29

Mavondo, 2000) and how country differences can be operationalized (Dow and Karunaratna, 2006), thorough discussions on whether there are other factors besides country differences affecting the psychological distance experienced towards countries are largely absent2. As a result, it could very well be that in addition to the examples of country differences provided by Johanson and Wiedersheim-Paul (1975) or Johanson and Vahlne (1977; 1990) there are factors other than country differences affecting psychic distance (and hence, location decisions).

A third issue concerning the relation between country differences and uncer-tainty is that the internationalization process model is somewhat inconsistent in what affects the uncertainty associated with internationalization decisions. Across foreign markets, the internationalization process model attributes a central role to country differences. These are claimed to negatively affect the uncertainty experienced towards countries (e.g. Johanson and Vahlne, 1990) and the readiness of firms to enter a foreign market. Within foreign markets however, the uncertainty experienced by foreign entrants is primarily attributed to a lack of knowledge. This inconsistency, which stems from many of the problems identified above, can only be resolved by reconsidering the two key assumptions reviewed in this section, namely the assumption that commitment decisions are closely linked to actual knowledge, and the idea that country differences constitute the main source of uncertainty in location decisions. Two notions from the organizational decision making literature may prove helpful here.

2.4 Suggestions from the literature on organizational decision-making

While the internationalization process model explicitly builds on theories of organi-zational behaviour (see section 2.2), the model largely overlooks two key notions from the literature on organizational decision-making; namely, the notion of bounded rationality and the role of cognition in perception. These notions offer valuable suggestions on how the issues discussed in the previous section can be addressed. Bounded rationality

The internationalization process model, which has its origins in the late 1960s (e.g. Carlson, 1966), is quite consistent with behavioural explanations of organizational decision making at the time. The model closely reflects the notion that firms do not have perfect knowledge of all available options and their consequences, which is one of the basic ideas to emerge from the Carnegie School. It is also the staring point of Simon’s notion of bounded rationality, which claims that “human behavior is intendedly rational, but only boundedly so” (1997 [1947]: 88). The concept of bounded

2 See Brewer (2007) for an exception.


30

rationality is very much implicit in Cyert and March’s (1963) The Behavioral Theory of the Firm, on which the internationalization process model builds. However, the internationalization process model builds on an early and narrow interpretation of bounded rationality and, as a result, adopts a rather limited view of the factors affecting human decision-making.

Simon introduced the concept of bounded rationality in recognition that decision makers often do not have perfect knowledge and understanding of all available options and their consequences. In addition, Simon argues that decision makers have only limited cognitive capabilities, which limits their ability to process information and to conceive alternative solutions. However, while decisions may therefore not always be optimal, decision makers nonetheless intend to act rationally given these boundaries to rationality. Simon first addressed the boundaries of rationality in Administrative Behavior (1947) and first used the phrase ‘bounded rationality’ in 1957 (Klaes and Sent, 2005). Since coining the term bounded rationality however, Simon’s own conception of rationality and decision making gradually evolved. In particular, Simon more and more came to emphasize that human action is based on the limited amount of actual information and knowledge available as well as the additional assumptions and beliefs which complement our understanding of reality (Klaes and Sent, 2005; Simon, 1991).

As the internationalization process model has remained relatively unchanged since the 1970s, it does not reflect the gradual change which the concept of bounded rationality has undergone. Instead, the internationalization process model continues to merely view a lack of knowledge as a key constraint to organizational decision-making. This emphasis on limited knowledge in fact corresponds more closely with the notion of intentional rationality—the more narrow interpretation of bounded rationality used in transaction cost theory (e.g. Williamson, 1981)—than Simon’s conception of bounded rationality. In doing so, the internationalization process model overlooks that in addition to (or even in the absence of) actual knowledge and information, decisions are also informed by subjective assumptions and beliefs. A recurring theme in this book will be that acknowledging that both knowledge and beliefs have a bearing on internationalization decisions may help us explain a much wider range of internationalization patterns.

Psychic distance as a cognitive phenomenon

The second notion which we can take from the early literature on organizational decision making (e.g. March and Simon, 1958), as well as from cognition research, is that perceptions are inherently linked to the knowledge structure and cognitive processes of decision makers. Knowledge structures transform and order information from the environment (Walsh, 1995), and give rise to the managerial perceptions and internal representations on which decisions are based (e.g. Anderson and Paine, 1975;


31

Table 2.2: Illustrative quotations from the literature on internationalization process theory and organizational decision-making

Quotations from internationalization process theory

Quotations from the literature on organizational decision-making

On the primacy of knowledge in decision-making

“There is a direct relation between market knowledge and market commitment” (Johanson and Vahlne, 1977: 28)

“That internationalization decisions have an incremental character is, we feel, largely due to this lack of market information and the uncertainty occasioned thereby” (Johanson and Vahlne, 1977: 26)

“In our model, knowledge is of interest because commitment decisions are based on several kinds of knowledge.” (Johanson and Vahlne, 1977: 27)

“behavior is determined by the irrational and nonrational elements that bound the area of rationality” (Simon, [1947] 1997: 323)

“By boundary conditions I mean the assumptions that have to be made” (Simon, 1991: 83)

“humans […] behave rationally, if at all, only relative to some set of “given” characteristics of the situation. These “givens” include knowledge or assumptions” (March and Simon, [1958] 1993: 172)

“To understand managerial processes in use, the presuppositions employed in deciding and acting must be understood” (Gioia, 1986: 349)

On the link between uncertainty and country differences

“lack of knowledge due to differences between countries […] is an important obstacle to decision making” (Johanson and Vahlne, 1977)

“firms enter new markets with successively greater psychic distance […] There they will see opportunities, and there the perceived market uncertainty is low” (Johanson and Vahlne, 1990: 13)

“because of lack of knowledge about foreign countries and a propensity to avoid uncertainty, the firm starts exporting to neighbouring countries or countries that are comparatively well-known and similar with regard to business practices etc.” (Johanson and Vahlne, 1975: 306)

“the perception of factors external to the boundary manager is a key factor in accounting for different decision frameworks and resulting strategies in the same objective environment” (Anderson and Paine, 1975: 813)

“the perception of the need for information as an indicator of uncertainty [is] important to understanding the [strategy] formulation process” (Anderson and Paine, 1975: 814)

“An explanation of problem solving is grossly incomplete if it does not account for what goes on in understanding the problem, or, what amounts to the same thing, in forming an internal representation of it.” (Simon, 1991: 228)


32

Stubbart, 1989; and Weick, 1979). How and what we perceive is therefore strongly linked to the content and structure of our knowledge structure.

This notion offers valuable leads for understanding the roots of psychic distance and the uncertainty decision makers experience towards countries. Unlike for example geographical distance or cultural distance, psychic distance is not absolute. It is a cognitive phenomenon, a subjective perception, and therefore not constant. Perceptions are not merely based on the information that reaches the decision maker; this information is processed, altered, and complemented by the observer’s cognition. What results is not a watered-down version of the actual situation but the decision-maker’s own ‘definition of the situation’ (March and Simon, 1958); a mental representation, a projection. This is what accounts for the subjective nature of psychic distance.

The implication is that what causes decision makers to perceive some countries as psychologically more distant than others is intimately linked to the knowledge structure of decision makers. Therefore, variation in the uncertainty experienced towards countries requires a cognitive explanation and cannot—or not merely—be explained in terms of the extent to which countries resemble or differ from each other. In other words, we need a cognitive explanation of what affects the uncertainty associated with location decisions. This offers an opportunity to reconcile the inconsistency in what affects the uncertainty associated with internationalization decisions.

2.5 Rethinking internationalization process theory: familiarity perceptions as a unifying concept

Internationalization process theory has a long history as the dominant behavioural perspective on internationalization processes. However, as discussed in section 2.3, several conceptual problems limit the type of internationalization processes which the internationalization process model can account for. As suggested in the previous section, these problems can be addressed by taking note of the suggestions from the literature on organizational decision making discussed above.

What follows from the preceding discussions is that it is not what we know, but what we think we know on which decisions are based. In addition, managerial perceptions are closely linked to the knowledge structure of decision makers. It is likely that both type of internationalization decisions—both location decisions and decisions on the degree of commitment to individual country markets—are subject to these notions. This offers scope for the development of a single concept to explain what drives internationalization decisions. In particular, these notions can be integrated by using the notion of familiarity perceptions as a central concept in understanding internationalization decisions.


33

Familiarity perceptions

The notion developed in this book is that the uncertainty experienced both within and across foreign countries does not merely stem from a lack of knowledge and information, but that it is more generally related to decision makers’ perceived understanding of foreign contexts. In other words, variation in the uncertainty experienced towards foreign countries may well stem from differing familiarity perceptions, which could be defined as decision makers’ self-perceived understanding of foreign host contexts. The difference with the internationalization process model lies in that decision makers may perceive foreign host contexts as relatively familiar despite a lack of actual experience, knowledge, and an actual understanding of these host contexts. Unsubstantiated beliefs, such as assumptions and generalizations, complement our understanding of reality and thus may partially compensate for a lack of actual knowledge. As perceived understanding and uncertainty are inversely related, decision makers who perceive a foreign host context as relatively familiar—be it due to actual knowledge, strong beliefs, or a combination of both—may experience less uncertainty than decision makers who perceive the same host context as less familiar, whether these differences in perceived familiarity are justified or not.

The notion of familiarity perceptions closely reflects the suggestions from the literature on organizational decision-making discussed above, and it may help address some of the conceptual problems with the internationalization process model identified earlier.

First, the notion of familiarity perceptions recognizes that both knowledge and beliefs may have a bearing on internationalization decisions, and that a lack of knowledge is therefore not necessarily as inhibitive to internationalization processes as internationalization process theory suggests. This corresponds closely both with current views in epistemology (see e.g. Moser, 2002) and with the notion of bounded rationality (e.g. Simon, 1947; 1991). Thus, incorporating the notion of familiarity perceptions may lead to a more realistic representation of the factors affecting decision making under uncertainty. As discussed in later chapters this may widen the theoretical scope of internationalization process theory, which is currently confined to incremental internationalization processes.

In addition, by establishing a link between decision makers’ perception of foreign host contexts and the uncertainty associated with internationalization decisions, the notion of familiarity perceptions provides a much needed cognitive explanation of uncertainty perceptions. This offers a starting point for a conceptual reconsideration of the psychic distance construct, which is potentially useful but whose effect on inter-nationalization decisions has not yet been conclusively established in empirical studies.

Finally, the notion of familiarity perceptions provides a single explanation of what causes the uncertainty experienced towards foreign host contexts by those


34

involved in internationalization decisions. It therefore increases the internal consistency of the internationalization process model, which currently relates the uncertainty experienced within foreign markets to a lack of knowledge while relating the uncertainty experienced across countries to country differences.

Knowledge

Beliefs

Familiarity perceptions

Internationalization decisionsExperience

Figure 2.1: Schematic representation of the internationalization decision process

Emerging research directions

The notion of familiarity perceptions offers a theoretically grounded solution to some of the conceptual problems of the internationalization process model. However, suggesting familiarity perceptions as a central concept for understanding internation-alization decisions also gives rise to many new questions. Three of these emerging research directions are addressed in the following chapters.

One of the first questions to come to mind is whether country differences really are as strongly linked to uncertainty perceptions as internationalization process theory assumes. The notion of familiarity perceptions suggests that the uncertainty experienced towards countries is strongly related to decision makers’ perceived lack of understanding of foreign host contexts. It is unclear how country differences feature here, and why country differences should be expected to be the main (and only) antecedents to psychic distance. At the least, the notion of familiarity perceptions suggests that the link between uncertainty and country differences is not straight-forward; especially since familiarity perceptions can be expected to bridge country differences. Chapter 4 takes up this theme by examining the extent to which both country differences and historical ties—a variable associated with familiarity perceptions—affect the location of foreign investment. In preparation of the study in


35

Chapter 4, Chapter 3 focuses the development of a measure of institutional country differences; a dimension which has received much attention recently, but for which an appropriate country-level indicator is markedly absent from the international business literature.

A second research theme which emerges is the effects of familiarity perceptions on entry-mode decisions. Due to the assumption that a lack of local knowledge defers high commitments upon entry, the internationalization process model has long assumed that inexperienced firms only gradually increase their commitment to foreign markets. As a result, the notion of committed entry modes has mostly belonged to the realm of transaction cost theorists. Yet forming beliefs about foreign host contexts requires no actual experience. At the very least, this means that the uncertainty experienced towards a foreign host context is not necessarily as high as the internationalization process model assumes. An important question therefore is whether the notion of familiarity perceptions allows for a behavioural explanation of committed entry modes. This is one of the topics of the case study in Chapter 5.

A third research direction is how learning processes affect familiarity perceptions, and how this affects the dynamics of internationalization processes. Internationalization process theory characterizes learning of foreign markets and foreign host contexts as a cumulative and gradual learning process, which progressively lowers the uncertainty firms experience locally. Acknowledging that uncertainty perceptions are affected by both knowledge and beliefs (i.e. the degree of perceived familiarity) complicates this picture. As the beliefs decision makers hold are unsubstantiated, initial preconceptions may prove to be either true and accurate, or incorrect. The implication is that the relation between local learning and the uncertainty firms experience is not unequivocal. For example, when initial beliefs and assumptions regarding the nature of markets and host contexts prove incorrect, perceived familiarity can be expected to decrease. Therefore, local experience may lead to an increase (rather than decrease) in the uncertainty firms experience towards a foreign market environment. The implications of such (un)learning processes, in particular how internationalizing firms respond to exposed knowledge deficiencies, is the second topic addressed by the case study in Chapter 5.

2.6 A summary and some concluding remarks

The internationalization process model, which builds on both A Behavioural Theory of the Firm (Cyert and March, 1963) and Penrose’s (1959) theory of the growth of the firm, has remained relatively unchanged since the 1970s. This is surprising for two reasons. First, a considerable amount of empirical research has been dedicated to testing the model’s predictions, and empirical results have often been conflicting (see section 1.3). Second, the model’s assumptions, which strongly influence the type of


36

internationalization processes the model predicts (and which it can account for), are very much open to discussion. While others have focused on the model’s assumptions regarding organizational learning (e.g. Forsgren, 2002), this chapter offered a critique of two of the model’s assumptions regarding internationalization decisions; namely, the importance of knowledge, and the link between country differences and uncertainty. In addition, this chapter pointed to the model’s inconsistency regarding the roots of the uncertainty associated with internationalization decisions. The critique developed in this chapter can be summarized as follows: First, the assumption that internationalization decisions are based on a firm’s actual knowledge of local conditions and that commitments are postponed in the absence of such knowledge, is unnecessarily restrictive. In overemphasizing the role of experiential knowledge, the internationalization process model ignores that other factors also have a bearing on decision making. Second, the proposed link between country differences and uncertainty, for which the internationalization process model makes use of the concept psychic distance, is underdeveloped and unconvincing. The lack of a proper conceptualization of the psychic distance construct hampers discussions on the factors affecting psychic distance other than country differences. Finally, the inter-nationalization process model is inconsistent in what is at the source of the uncertainty associated with internationalization decisions. While the uncertainty firms experience within countries is related to a lack of knowledge, across countries it is linked to country differences. The internationalization process thus overlooks key notions from the literature on organizational decision-making. In particular, the internationalization process model overlooks that decisions are based both on the limited knowledge and information available as well as on the beliefs and assumptions which decision-makers hold to be true (e.g. Simon, 1947; 1991). In addition, in the model’s discussion on the uncertainty firms experience towards alternative host countries, the internationalization process model underemphasizes that, as a perception, what causes decision-makers to perceive some countries as psychologically more close or distant than others is intimately linked with decision-makers’ knowledge structure. Understanding such differences therefore requires a cognitive explanation. In this chapter it was proposed that these notions can be quite easily incorporated in the internationalization process model by recognizing the notion of familiarity perceptions as a central concept. The perception of familiarity refers to decision makers’ self-perceived understanding of foreign markets and foreign host contexts, which stems from both the actual knowledge decision makers have and the beliefs that are held to be true on the nature of such markets and their contexts. It was suggested that as perceived understanding and uncertainty are inversely related, a lack of perceived familiarity with foreign markets and host contexts forms the main source of uncertainty when it comes to internationalization decisions. As both location decisions and decisions on the degree of local involvement are essentially commitment


37

decisions, familiarity perceptions may affect both and hence may serve as a unifying concept in behavioural explanations of internationalization decisions. While adopting the notion of familiarity perceptions raises several new questions and opens up new research directions (three of which are explored in the next chapters), recognizing the notion of familiarity perceptions as a central construct in internationalization decisions could significantly broaden the theoretical scope of the internationalization process model. Due to the assumption that a lack of knowledge is a key inhibiting factor to internationalization, the theoretical scope of internationalization process theory is currently confined to gradual internationalization processes. By easing this constraint, internationalization process theory might be able to provide a behavioural explanation of internationalization processes that proceed less gradually. In addition, the notion of familiarity perceptions may go a long way in opening up ongoing (but quite myopic) debates on the effects of country differences on location decisions. Exploring the value of the concept of familiarity perceptions in understanding internationalization decisions, as well as uncovering its implications, will be the underlying rationale of the following chapters.

Chapter 3

A measure of comparative institutional distance

3.1 Introduction

Country differences are central to many of the questions addressed in international business (IB), and intrinsic, substantive country differences have been employed to explain a wide range of behaviour by multinational enterprises. National cultural differences for example, have been used to explain the location of MNE activity (e.g. Grosse and Goldberg, 1991; Grosse and Trevino, 1996), entry and establishment mode selection (e.g. Kogut and Singh, 1988; Drogendijk and Slangen, 2006), internationalization sequence (Erramilli, 1991), or international joint venture dissolution (Park and Ungson, 1997; Hennart and Zeng, 2002). In recent years, institutional differences and the notion of institutional distance have received particular attention; evidenced for example in a string of special issues on the role of institutions in the Journal of International Management (2003), Organization Studies (2005) and, recently, the Journal of International Business Studies (2008).

What institutions are however, and what types of institutions are of interest, differs by level of analysis and by the subject under consideration (Aoki, 2001; Scott, 1995). As a result, several varieties of institutionalism have emerged (Scott, 1995), and various measures of institutional distance have been developed and applied in correspondence with these different varieties of institutionalism. Three varieties in particular have recently dominated in IB research: new institutional economics, new organizational institutionalism, and comparative historical institutionalism1. For the first two strands of institutionalism, relatively well-developed measures of institutional distance are available, such as measures on the rule of law as employed in

1 Comparative institutionalism here refers to the varieties of capitalism approach rather than Aoki’s and others game-theoretic approach to macro-economic institutional diversity and change.


40

comparative corporate governance (e.g. La Porta, Lopez-de-Silanes, Shleifer, and Vishny, 1998), or there is consensus on how suitable instruments can be developed, as in the case of new organizational institutionalism (e.g. Kostova, 1999; and Busenitz et al., 2000).

The starting point of the third variety of institutionalism, comparative historical institutionalism (e.g. Whitley, 1999; Hall and Soskice, 2001), is that the key institutional elements in a society are reciprocally constituted. Key institutional and societal features are presumed to develop interdependently over time, resulting in intrinsic differences in economic organization between countries. One of the more elaborate comparative institutional frameworks available is developed in the work of Richard Whitley on the varieties of capitalism (Whitley, 1992; 1999). Whitley points to the coherent variation of countries on key institutional features and business system characteristics, such as between characteristics of the domestic financial system and the type of owner control, on the basis of which distinctive business system types can be distinguished. Due to the complex interdependencies between societal features, this strand of institutionalism largely relies on extensive systematic qualitative comparisons to describe such differences between countries (Maurice, 2000). Partially as a result of this qualitative orientation, no indicator of institutional distance is currently available which builds on the thought of comparative historical institutionalism.

This is a major omission from the IB literature, given the central role of intrinsic country differences in our understanding of international business. It implies that for many IB researchers, currently available measures of institutional distance do not suffice. The institutional indicators borrowed from international economics are indicative of the effectiveness of (formal) institutions, such as in protecting property rights and in preventing corruption, rather than of intrinsic differences in country-level institutions such as between Germany and the United Kingdom. Measures of institutional distance developed from the perspective of new organizational institutionalism instead rely on the decomposition of the institutional context into the regulative, normative, and cognitive components which guide social behaviour (Kostova, 1997, 1999; Walsh, 1995; Busenitz et al., 2000). However, social behaviour is constrained by different institutional elements in different settings. Such measures can therefore only be compiled with respect to narrow domains (Kostova and Roth, 2002), such as the legitimacy of a particular organizational practice, which is at a much lower level of analysis than the majority of studies in international business.

The objective in this chapter is to develop a measure of institutional distance which captures intrinsic, substantive institutional country differences in economic organization, rather than differences in institutional effectiveness. The measure or scale of institutional distance developed in this chapter is based on the key institutional features applied by Whitley (1999) to distinguish and characterize distinctive business systems. In the development of such a measure of comparative

Chapter 3: Institutional Distance

41

institutional distance, three consecutive steps are taken. The first step is the identification of suitable indicators which approximate these key institutional features. The second step is the verification of the validity of the selected indicators. To that end, we perform a two-step cluster analysis to assess whether Whitley’s business system typology can be reproduced on the basis of these indicators. The final step is the development of a measure of institutional distance, and the calculation of institutional distances between the OECD countries used in our sample. We start this chapter with a discussion of the three varieties of institutionalism which have dominated international business, and with a discussion of Whitley’s business system typology.

3.2 Varieties of institutionalism and institutional distance

Scholars in economics, sociology, political science and organization studies rely on vastly different conceptions of what institutions are. Such varieties of institutionalism differ in whether institutions are primarily perceived as regulative systems, normative systems or cultural-cognitive systems, as well as in the level of analysis (Scott, 1995). As a result, depending on focus and level of aggregation, scholars with an interest in institutions have come to focus on such diverse topics as the effect of formal regu-lations on the location of foreign investment (e.g. Bevan, Estrin, and Meyer, 2004), the effect of new technologies on job roles in radiology departments (Barley, 1986), or the role of organizational symbolism (Dandridge, Mitroff, and Joyce, 1980). Ultimately, as Aoki (2001) concludes, “which definition of an institution to adopt is not an issue of right or wrong; it depends on the purpose of the analysis” (Aoki, 2001: 10).

Of all the varieties of institutionalism, three varieties in particular have dominated international business research over the past two decades, namely new economic institutionalism (or rather new institutional economics), new organizational institutionalism, and comparative historical institutionalism. The identification of the dominant varieties of institutionalism is of course dependent on the issue at hand, and on where one draws the line between international business and other domains. Morgan and Kristensen (2006) for example only distinguish between organizational institutionalism and comparative historical institutionalism, which suits their discussion on the institutional duality within MNEs. The three strands of institutionalism which are considered here however, correspond with the dominant themes which are addressed within the broad domain of international business; both in terms of research questions and in terms of level of analysis. While the aim is not to be exhaustive—a rare feat when one attempts to discuss the many (and heterogeneous) strands and sub-strands of institutionalism—an attempt is made to position each variety within either economics or sociology. It is subsequently argued that for each variety of institutionalism appropriate measures of institutional differences are available, except for comparative historical institutionalism.


42

New Institutional Economics The first dominant strand of institutionalism in international business, new institutional economics, is strongly rooted in microeconomic thought. New institutional economics has found widespread application in, for example, historical economics (North, 1990, 1991) and in game theoretic approaches to the formation and change of macro-economic institutions (Aoki, 2001), but also in the sub-fields of international business in which the effectiveness of country-level institutions is paramount. The kernel of new institutional economics is perhaps best understood in contrast with the view of institutions from which it intended to differentiate itself, that of the ‘old’ institutional economists such as Thorstein Veblen, John Commons, and Gunnar Myrdal.

At the beginning of the 20th century, and in particular in the interbellum, a group of economists rebelled against the neo-classical view of the economy as a relatively closed model. The fundamental principle of what became known as institutional economics was that as all institutional features of society are interdependent (including individual preferences), the analysis of economic problems cannot occur without taking into account the dynamics of the entire social system (Myrdal, 1978). However, the acknowledgement of institutional idiosyncrasies and the complexities of society implied that their institutional analyses often resulted in “tentative generalizations and mere plausible hypotheses” (Myrdal, 1978: 775), which to others appeared to contribute little to the formation of theory (Coase, 1998). Following World War II therefore, the role of institutional economics was largely marginalized in favour of conventional economics (Hodgson, 2007; Lowndes, 1996).

Widespread appreciation in economics for the role of institutions returned in the 1970s and 1980s, most notably through the work of Douglas North and Oliver Williamson, in the form of new institutional economics. Both old and new institutional economists acknowledge that institutions matter. The crucial difference however is that new institutional economists view institutions as endogenous, or as adaptable constraints, rather than as conditioning individual choice. As such, individuals are assumed to create and shape institutions independent of cultural preferences, and they are assumed to do so according to the principles of microeconomics (Mayhew, 1989). This permits a detailed analysis of both institutions and their effectiveness. The hallmark definition of institutions in new institutional economics comes from historical economist Douglas North (1990), who states that “institutions are the rules of the game in a society or, more formally, are the humanly devised constraints that shape human interaction” (1990: 3). Although North and others acknowledge the existence of both formal and informal institutions, in practice new institutional economics is often reflected in a focus on (compliance with) formal rules and regulations (Williamson, 2000).


43

Current discussions on institutions in economics have moved beyond the simple dichotomy between old and new institutional economics. Aoki (2001), Greif (1998) and others for example, have adopted a largely game-theoretical approach to under-standing the emergence of institutions. While comparative institutional analysis, as it has become known, remains strongly rooted in new institutional perspectives of institutions, comparative institutional analysts pay particular attention to the inter-dependence between the outcomes of games in various economic domains (Aoki, 2001). However, perhaps more interesting in the light of the current discussion is the recent revivalism of old institutional economic thought, in particular the evolutionary work of Veblen and the notion of endogenous preferences, in understanding socio-economic evolution (e.g. Brette, 2006; Hodgson, 1998, 2003, 2007; Potts, 2007). A similar trend is that even new institutionalists such as Douglas North increasingly acknowledge the cognitive implications of institutions (Dequech, 2002; Hodgson, 2007).

In international business however, most economics-based approaches to institutions essentially remain new institutional economic perspectives on what institutions are, and on how and why they affect organizations. Therefore, what continues to distinguish economics-based views of institutions from sociological and organization theory-based views of institutions in IB is that saliently, institutions are presumed to constrain the actions of actors in the pursuit of their interests, but institutions are presumed to have no or little effect on the interests which actors pursue, or on the preferences of actors other than what the rules of the game exclude. For example, as Aguilera and Jackson (2003) note, agency-approaches to comparative corporate governance traditionally focus on characterizing different governance mechanisms, but are unable to account for the observed differences in governance. In addition, institutions or institutional characteristics are implicitly assumed to be relatively unrelated; there is at least more concern for the effectiveness of individual institutions than for the idea of coherent institutional configurations. This has translated into what Jackson and Deeg (2008) term a “variable-based approach” to institutions, in which institutions are conceived as factors which quite independently “constrain or impact […] the cost of IB activity” (Jackson and Deeg, 2008: 542).

This is not necessarily problematic. Within international business, new insti-tutional economical perspectives are most often assumed in studies which focus at the effects of differences in the effectiveness of country-level institutions. Examples are studies on the effect of formal institutions on trust in business partners (Rao, Pearce, and Xin, 2005), or on the effectiveness of macro-economic institutions in providing the stable institutional environment necessary for the establishment of wholly-owned subsidiaries (as in Meyer, 2001; Meyer and Peng, 2003; and Dikova and Van Witteloostuijn, 2007). For many studies implicitly adopting a new institutional economical perspective on institutions, therefore, the selection of indicators on insti-tutional effectiveness simply suits their research objectives. It becomes problematic


44

however when studies include indicators on institutional effectiveness where a measure of intrinsic institutional differences would be more appropriate. New Organizational Institutionalism The second dominant variety of institutionalism within international business is new organizational institutionalism (Meyer and Rowan, 1977; DiMaggio and Powell, 1983; Powell and DiMaggio, 1991). Rooted in sociology and organization theory, the focus of new organizational institutionalism is on organizational forms and organizational practices (Powell and DiMaggio, 1991) rather than on ‘the rules of the game’ of new institutional economics. Similar to how new institutional economics is best understood when contrasted with old institutional economics, new organizational institutionalism is best understood in contrast to ‘old’ organizational institutionalism, even if the differences between the two are less pronounced than in the case of old and new institutional economics (Lowndes, 1996).

The use of the phrase ‘old institutionalism’ is somewhat deceptive, as it may suggest that the institutionalisms in sociology and organization science which predated new organizational institutionalism are relatively homogeneous. This is not the case, as for example Scott (1987) illustrates in a seminal review of the “many faces of institutional theory” (1987: 493). The ‘old’ organizational institutionalism against which the ‘new’ positioned itself however, is the strain of organizational institutionalism of which Philip Selznick has been singled out as the main proponent (see Powell and DiMaggio, 1991); not the least because of his hallmark definition of organizational institutions.

The focus of old organizational institutionalists such as Selznick (1949, 1957; Broom and Selznick, 1955) and Clark (1960, 1972) has been on explaining the distinctiveness or ‘character’ of individual organizations. It was argued that organizations develop such distinctive characters, such as distinctive practices (Clark, 1960) and distinctive competences (Selznick, 1952), because in the interplay between internal interests and the external environment some practices become institutionalized. Such practices persist even when conditions change because they become “infuse[d] with value beyond the technical requirements of the task at hand” (Selznick, 1957: 17). Although in current depictions of the old institutionalism conflict, power and influence are often emphasized (e.g. Powell and DiMaggio, 1991; Greenwood and Hinings, 1996), old institutionalists see institutionalization as a neutral adaptive mechanism of organizations (Selznick, 1996) which promotes stability by creating “orderly, stable, socially integrating patterns out of unstable, loosely organized, or narrowly technical activities” (Broom and Selznick, 1955: 238).

The notion of institutionalization in old and new organizational institutionalism differs primarily in whether institutionalization is argued to occur within individual organizations or rather within specific domains or fields. In old institutionalism,


45

institutions are intra-organizational patterns and activities which makes the organization the primary unit of analysis (Greenwood and Hinings, 1996). Instead, in new institutionalism institutionalized elements are part of more widely shared belief systems (Scott, 1987). The implication is that whereas the old organizational institutionalist idea of institutionalization can be applied to explain differences between organizations, the ‘new’ uses institutionalization to explain homogeneity in organizational forms and practices across organizations (Powell and DiMaggio, 1991).

Broadly speaking, in the perspective of new organizational institutionalism “institutions are taken for granted ways of acting, which derive from shared regulative, cognitive and normative frames” (Morgan and Kristensen, 2006: 1470). Such beliefs, myths, and symbols are shared across organizational sectors, and institutionalized organizational forms and conventions therefore differ by organizational field rather than by individual organization (Powell and DiMaggio, 1991). Organizations conform to such institutionalized beliefs because it is rewarding: Conformity increases organizational legitimacy, access to resources and, ultimately, organizational survival (Meyer and Rowan, 1977). In contrast with for example new institutional economics, in new organizational institutionalism behaviour is not only restricted through formal institutions, but it is also guided and encouraged by cultural-cognitive systems and normative pressures (DiMaggio and Powell, 1983). It is such isomorphic pressures which explain convergence in organizational structures and practices.

In international business—international management in particular—the notion of new institutional distance has been primarily developed and refined in the work of Kostova and others (Kostova, 1997; 1999; Kostova and Zaheer, 1999; Kostova and Roth, 2002). New organizational institutionalists in international business hold that when the institutional environment of countries in which the MNE operates differ considerably, MNEs face a considerable challenge in establishing and maintaining internal and external legitimacy (Kostova and Zaheer, 1999), and in transferring organizational practices to foreign subsidiaries (Kostova, 1999; Kostova and Roth, 2002). The larger the institutional distance between the home and the host context, the larger the institutional duality experienced by local subsidiaries (Kostova and Roth, 2002), and the larger the complexity faced by MNEs. Various contributions demonstrate how the institutional environment can be decomposed into the respective regulative, normative, and cultural-cognitive elements which affect organizational behaviour in a particular setting (Kostova, 1997; Busenitz et al., 2000; Kostova and Roth, 2002). Subsequently, country institutional profiles can be compiled which reflect the extent to which the institutional environments of countries differ. However, since the institutional elements which guide behaviour in any particular setting are specific to the issue at hand, such profiles and institutional distances cannot be generalized (Kostova, 1997).


46

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Wor

ld C

ompe

titi

vene

ss Y

earb

ook

Cou

ntry

Ris

k R

atin

gs: E

urom

oney

Reg

ulat

ive,

nor

mat

ive,

an

d co

gnit

ive

dim

ensi

ons

Reg

ulat

ive,

nor

mat

ive,

an

d co

gnit

ive

dim

ensi

ons

Reg

ulat

ive,

nor

mat

ive,

an

d co

gnit

ive

dim

ensi

ons

Nor

mat

ive

and

cogn

itiv

e in

stit

utio

nal d

ista

nce

Nor

mat

ive

dist

ance

Reg

ulat

ive

dist

ance

Cul

tura

l dis

tanc

e

Reg

ulat

ive

dist

ance

Nor

mat

ive

dist

ance

Qua

lity

man

agem

ent

Ent

repr

eneu

rshi

p

Pra

ctic

e ad

opti

on

Kno

wle

dge

tran

sfer

Subs

idia

ry s

taff

ing

Subs

idia

ry s

urvi

val

Scot

t (19

95)

Scot

t (19

95)

Scot

t (19

95)

Scot

t (19

95)

Scot

t (19

95)

Nor

th (

1990

),

Scot

t (19

95)

Kos

tova

(1

997)

Bus

enit

z,

Góm

ez, a

nd

Spen

cer

(200

0)

Kos

tova

and

R

oth

(200

2)

Jens

en a

nd

Szul

ansk

i (2

004)

Gau

r, D

elio

s,

and

Sing

h (2

007)

Gau

r an

d Lu

(2

007)

Tab

le 3

.1: I

llust

rati

on o

f the

rec

ent u

se o

f ins

titu

tion

al in

dica

tors

(co

ntin

ued)

N

ew

orga

niza

tion

al

inst

itut

iona

lism


48

The use of new institutional distance in our understanding of international business has become more and more widespread. Xu and Shenkar (2002) for example suggest how the regulative, normative, and cognitive distances between the home and the host country may affect the location and entry mode strategy of MNEs. Others rely on new organizational institutionalist thought to explain expatriate adjustment (Ramsey, 2005), subsidiary staffing strategies (Gaur, Delios, and Singh, 2007), or the organizational identification of subsidiary managers (Vora and Kostova, 2007). However, an important limitation of new institutional distance is that the higher the level of aggregation, the more difficult it becomes to identify and segregate the relevant regulative, normative, and cultural-cognitive institutional elements. This is especially the case when one relies on publicly available data sources rather than on tailor-made surveys (see e.g. Xu, Pan, and Beamish, 2004). Therefore, measures of institutional distance which build on new organizational institutionalism are most suited to the analysis of the legitimacy and transferability of particular practices, rather than the analysis of firm-level phenomenon in international business. Comparative Historical Institutionalism Comparative historical institutionalism, in various guises (Whitley, 1999; Maurice and Sorge, 2000; Hall and Soskice, 2001), starts from the idea that a country’s key institutional elements are reciprocally constituted, in the sense that key institutional and societal features developed interdependently over time. This is a characteristic it shares with old institutional economics (see Table 3.2), which in similar vein is strongly rooted in the social sciences. Institutions are predominantly conceived as social institutions at the societal level, whose relations with economic actors and with the organization of economic activity are contextually embedded and therefore non-universal. From the perspective of comparative historical institutionalism, it is the reciprocal constitution of institutions and actors which explains the emergence and persistence of intrinsic differences between societies, such as in the organization of work (Maurice et al., 1986) and production systems (Hollingsworth and Boyer, 1997), and, more generally, in the form of economic organization (Whitley, 1999).

Within the domain of international business, comparative historical insti-tutionalist thought has been employed to understand the effect of institutional characteristics of both the country of origin and of the host country on the structure and organizational practices of MNEs (Kristensen and Zeitlin, 2001). For example, Harzing and Sorge (2003) find that the country of origin strongly affects the types of corporate control mechanisms employed. Matten and Geppert (2004) suggest that substantive characteristics of both the home and host institutional context affect subsidiary work-system design, while Saka (2004) relates such differences to the transfer of knowledge. Recent work has emphasized how the institutional duality with which MNE subsidiaries


49

are confronted may lead to micro-political games and power struggles (Dörrenbächer and Geppert, 2006), such as over the standardization of practices and policies (Ferner et al., 2005; Morgan and Kristensen, 2006), or over the internal division of resources (Morgan and Kristensen, 2006).

To characterize such inherent country differences, comparative institutionalists have traditionally relied on ‘thick’ qualitative descriptions (Maurice, 2000). Though insightful, such descriptions often tend to be relatively particularistic (e.g. Van Iterson and Olie, 1992), and extensive systematic characterizations of large groups of countries are relatively rare. Hall and Soskice (2001) for example rely on the insightful but relatively simple dichotomy between liberal and coordinated market economies to characterize and classify Anglo-Saxon and continental European economies. To date, the most elaborate and systematic attempt to classify countries by institutional characteristics remains to be found in the work of Richard Whitley (1992, 1994, 1999). Whitley’s characterization and classification of distinctive business system types, which culminates in the comparative business systems framework, is therefore often applied to characterize the institutional environment of countries.

The comparative business systems framework builds on the systematic differences in institutional arrangements and economic activity observed in comparative analyses

Table 3.2: Classification of Varieties of Institutionalism

Nature of institutions

Focus of analysis Endogenous Exogenous

Institutions New institutional economics

Old organizational institutionalism

New organizational institutionalism

Institutional interdependencies

Comparative institutional analysis

Old institutional economics

Comparative historical institutionalism

Note: Given the distinctive nature of the various varieties of institutionalism, several alternative classifications are imaginable, such as by level of analysis, or by disciplinary origins.


50

of both European and Asian market economies (e.g. Hamilton and Biggart, 1988; Lane, 1992; Maurice, Sellier, and Silvestre, 1986; Sorge, 1991; Van Iterson and Olie, 1992; Whitley, 1990). The key notion, as in comparative institutionalism in general, is that the way in which economic activities in countries are organized is often internally consistent, and that the characteristics of market economies are closely related to the dominant type of institutions (Whitley, 1994; 1999). Market economies are argued to differ mainly in the dominant type of ownership relations, in how the relations between economic actors are coordinated, and in the form employment relations take (Whitley, 1998). The particular form a market economy takes is assumed to be particularly dependent on four key institutional dimensions: the role assumed by the state, the characteristics of the financial system, the skill development system, and the norms and values which resonate in work relations (Whitley, 1998, 1999). The more specific and coherent the institutions, the more distinctive and cohesive business systems arise. Similarly, substantively more different institutions translate into substantively more different market economies.

Despite the intrinsic interest of IB scholars in the effects of inherent country differences on the nature of the MNE (note for example the considerable literature on the effects of cultural country differences), no measure of institutional distance is currently available which allows for the systematic analysis of the effect of inherent societal-level institutional differences. As a result, while the many qualitative studies which draw on comparative historical institutionalist thought demonstrate the importance of inherent institutional differences in our understanding of the MNE, comparative historical institutionalism is poorly reflected in quantitative studies in IB. In the remainder of this chapter we aim to address this major omission from the IB literature by developing a measure of institutional distance which draws on Whitley’s business system typology (Whitley, 1999).

3.3 Methodology

Contrary to organizational institutional distance (e.g. Kostova, 1997; Kostova and Roth, 2002), or cultural distance for that matter (Kogut and Singh, 1988), the indicator of comparative institutional distance developed here aims to be indicative of inherent country differences, rather than of differences in latent psychological traits. Whether scales or measures which do not intend to measure a latent psychological trait or construct are meaningful, mainly depends on whether the scores on such indicators correspond with theoretically expected outcomes, and on whether the indicators differ sufficiently from indicators for different concepts. The measure of comparative institutional distance proposed in this chapter is therefore developed in the following interrelated steps: the selection of suitable indicators and a suitable data source, an assessment of the validity of these indicators through two-stage cluster analysis, and the subsequent design of the measurement instrument.


51

Data Source We selected the Global Competitiveness Report (2000) as our primary data source2. The Global Competitiveness Report, based largely on survey responses, is published annually by the World Economic Forum and contains annually collected country data on key institutional and economic characteristics. The advantage of using the Global Competitiveness Report stems both from the wide range of scales on institutional characteristics included in the survey, and from the use of standardized questions which facilitates systematic comparison. For these reasons, the Global Competitiveness Report is a frequent source of reference for institutional data (e.g. Rao, Pearce, and Xin, 2005; Xu, Pan, and Beamish, 2004; Gaur and Lu, 2007). While the questions in the questionnaire of the Global Competitiveness Report are not specifically designed to reflect the institutional features of business systems, the indicators are of use to the present study if the variety in country scores corresponds closely with the theoretically expected variety in inherent institutional differences between countries. In such instances, these indicators can be appropriately used as proxies for the corresponding institutional characteristics. As discussed later on, the extent to which the two-step cluster analysis reproduces Whitley’s business system typology is a good indication of the validity of the selected indicators, and of the empirical validity of the business systems framework in general. Sample For the verification of our measure of comparative institutional distance, we selected a sample consisting of all OECD countries from the Global Competitiveness Report. This is done as Whitley’s business system typology largely applies to market economies in which stable social institutions have materialized, which mainly applies to the industrialised countries included in the OECD. An additional argument is that the typology of business systems has been developed on the basis of a relatively small set of mostly well-developed countries. This modest set of countries includes (near-)ideal-types which have been frequently characterized in the literature, such as Germany, the UK, and South Korea. In order to assess the validity of our measure, it is therefore considered important to include these countries in our sample. The sample of OECD countries consists of all thirty member states.

2 We selected the 2000 edition of the Global Competitiveness Report because in later editions the wording of many questions was altered, which obscured substantive differences in, for example, the role of the state, skill development, or trust and authority relations.


52

Selection of variables We matched the key institutional features identified by Whitley (1999) with indicators from the Global Competitiveness Report 2000 which best captured these institutional characteristics (Table 3.3). Such a ‘deductive approach’ to the selection of clustering variables (Ketchen and Shook, 1996) is recommended when the clustering variables are strongly tied to extant theory, and tends to produce better results (Punj and Stewart, 1983). Table 3.4 presents a correlation matrix of the selected indicators. A list of the corresponding questions used in the questionnaire of the Global Competitiveness Report can be found in Appendix A. We identified appropriate indicators for all institutional features, except for the dominant organizing principle of unions, the extent to which bargaining is centralized, and the more specific extent to which communal norms govern authority relations. The rationale for the selection of indicators is explained below by institutional area.


53

Table 3.3: Institutional indicators

Key institutional features Indicatorsa

The state

Dominance of the state and its willingness to share risk

Independence of government policies from elites and special interest groups (3.05)

The extent to which government subsidies promote competition (3.03)

State antagonism to collective intermediaries

The pervasiveness of industrial clusters and specialized institutions (10.16)

Extent of formal regulation of markets The burden of regulation (3.01)

Financial systems

Capital market or credit based Access to external finance (8.04)

The use of the stock market (8.11)

Skill development and control system

Strength of public training system The difference in quality of schools available to rich and poor children (6.02)

Strength of independent trade unions The extent of union power and influence (6.10)

Trust and authority relations

Trust in formal institutions Public trust of politicians (4.16)

Predominance of paternalist authority relations

The willingness to delegate authority to subordinates (11.3)

The extent to which management-worker relations are cooperative (6.09)

a Corresponding items in the Global Competitiveness Report 2000 are in parenthesis.


54

10

0.61

*

9

0.80

**

0.64

**

8

0.03

0.11

-0.1

2

7

0.34

0.55

**

0.54

**

0.43

*

6

-0.1

5

-0.2

9

0.18

0.07

-0.2

6

5

0.26

0.19

-0.0

0

0.50

**

0.42

*

0.20

4

0.26

0.23

0.26

-0.1

9

0.60

**

0.43

*

0.41

*

3

-0.0

2

0.33

-0.1

2

0.36

0.11

0.21

0.46

*

0.31

2

-0.0

2

0.66

**

0.40

*

0.18

0.25

-0.0

2

0.59

**

0.53

**

0.37

*

1

0.75

**

0.27

0.73

**

0.61

**

0.25

0.35

-0.0

5

0.72

**

0.56

**

0.45

*

s.d.

0.58

0.78

0.59

0.61

0.31

0.76

1.34

0.91

1.27

0.95

0.75

Mea

n

3.65

3.99

4.51

3.68

4.04

5.19

4.90

4.32

3.95

4.68

5.06

Tab

le 3

.4: C

orre

lati

on m

atri

x

Var

iabl

e

1. I

ndep

ende

nce

of

gove

rnm

ent p

olic

ies

2. S

ubsi

dies

pro

mot

e co

mpe

titi

on

3. P

erva

sive

ness

of

inte

rmed

iari

es

4. B

urde

n of

reg

ulat

ion

5. A

cces

s to

ext

erna

l fi

nanc

e

6. U

se o

f sto

ck m

arke

t

7. E

qual

ity

scho

olin

g

8. U

nion

pow

er

9. T

rust

in p

olit

icia

ns

10. D

eleg

agti

on o

f au

thor

ity

11. M

anag

emen

t wor

ker

rela

tion

s

*p<

0.05

; **p

<0.

01.


55

The state. Three characteristics of the role of the state are particularly important in promoting and sustaining different forms of economic organization: the strength of the state, the tolerance of the state for intermediate associations between the state and firms, and the extent to which the state is involved in the regulation of markets (Whitley, 1999).

The first feature refers both to the strength of the state in relation to special interest groups such as social elites, and to the role of the state in the development of economic activity. While these are essentially two separate features, taken together this institutional characteristic reflects the extent to which firms are dependent on support from the state through state policies. Two indicators were selected to reflect inherent differences in the dominance of the state. The first indicator reflects the extent to which government policies are independent from elites and special interest groups. The second indicator is the extent to which government subsidies promote fair competition. The assumption here is that states which assume a more developmental role are more selective in granting subsidies. States with an arm’s length approach, on the other hand, are assumed to have a greater interest in pursuing policies which promote fair competition. As expected, scores on the two selected indicators are highly correlated (r = 0.75).

To reflect the degree of state antagonism to intermediary associations, an indicator was selected from the Global Competitiveness Report which signifies the pervasiveness of industrial clusters and specialized institutions. The extent of formal regulation of markets is reflected by the burden of regulation which firms experience. The assumption is that the type of regulatory role assumed by the state is reflected in the number of regulations with which businesses have to comply. As would be expected, the burden of regulation correlates strongly with both the extent to which government policies are independent from special interest groups (r = 0.73) and with the extent to which subsidies promote fair competition (r = 0.66).

Financial systems. Financial systems can differ considerably in how capital is raised. Generally, the distinction is made between financial systems which rely on external capital markets, and financial systems which are credit-based and where borrower and lender are more interlocked. As Monnet and Quintin (2007) illustrate, such differences persist even if fundamental characteristics of domestic financial systems converge. To reflect these differences, two indicators are selected. The first indicator reflects the general availability of external finance, while the second indicator reflects the general use of the stock market. Considered together, high scores on both reflect financial systems which rely heavily on the capital market. Low scores reflect financial systems where capital markets are tight or weakly developed, and where as a result businesses are reliant on other capital allocation processes, resulting in more credit-based financial systems. The availability of external funding and the use of the stock market however are two distinct characteristics of domestic financial systems


56

(Bencivenga, Smith, and Starr, 1996; Greenwood and Smith, 1997), and the correlation between these indicators subsequently is low (r = 0.22).

Skill development and control system. The dimension on skill development and control system represents both the extent to which practical learning and formal public education are integrated, and the extent to which the development of practical skills is jointly organized and/or certified by the state, unions, and firms. From the perspective of the state, a strong collaborative public training system requires an education system where the aim is not to filter out the failures from the academic high-fliers, but rather to ensure the overall quality of the output of the education system; whether this leads to practical skill training or to the pursuit of higher education. As Maurice, Sellier, and Silvestre (1986) illustrate, in Germany the strength of both university education and professional education—a collaborative effort of both the state, unions, and employers—has the effect that worker placement is less strongly associated with the level of general education than in France, and more strongly with occupational skills. To the contrary, the selective and generalist nature of the French education system parallels a work system in which both occupation and status are more strongly associated with the level of general education which one has attained.

It is presumed here that the overall strength of the public education system is reflected in the extent to which the quality of schools available to children from rich and poor families differs, with stronger educational systems resulting in less difference in the quality of education available to the rich and the poor. This seems reasonable. Maurice et al. (1986) find that in France, the probability of the child of a senior manager attaining a baccalaureate is nearly six times higher than that of the child of an agricultural or industrial worker. This is not surprising. In countries where job placement, wage, and social standing correlate more strongly with the level of general education, parents have a greater incentive to pursue access for their children to schools of higher standing and quality. In countries where professional success is based on progress through the educational system rather than on occupational skill, children of rich families are therefore even more likely to attend schools of higher quality, and are even more predisposed to attain a degree of higher education, than in countries with a strong collaborative education system. We therefore select the indicator on educational equality from the Global Competitiveness Report to reflect the overall strength of the public training system.

To reflect the strength of independent trade unions, we select the Global Competitiveness Report indicator on the extent of union power and influence. As Whitley (1999) argues, strong unions affect the strategic orientation of domestic firms, the adoption of technologies, and even the structure of markets. Strong unions, however, are not necessarily reflected in an egalitarian or more professionally oriented education system. For example, whereas unions in Australia have traditionally exerted reasonable influence, especially in some industries (Hampson and Morgan, 1999), the


57

national education system continues to be largely generalist in nature (Bagnall, 2000)3. And whereas the Swiss education system is characterized by a dual system of higher education in which vocational colleges feature prominently (Hanhart and Bossio, 1998), the certification of skills is largely in the hands of the state and sees little involvement of the traditionally weak (Höpflinger, 1981) labour unions. The modest correlation between equality of schooling and union power (r=0.34) reflects this.

Trust and authority relations. Prevailing norms and values regarding trust and authority affect the structuring of employer-employee relationships as well as the structuring of exchange relations between firms (Whitley, 1999).

While trust comes in different forms (Couch, Adams, and Jones, 1996), key for understanding differences in both socio-economic order and in authority relationships is the type of generalized trust individuals put in both unknown others and in the social institutions which promote and guarantee such trust. Generalized trust is a rather homogeneous construct, affecting for example both social capital (Paxton, 1999) and superior-subordinate relations (Payne and Clark, 2003). We therefore assume that the extent to which formal institutions are able to generate and guarantee trust is—at least in part—associated with the trust people put in the politicians which shape and govern these institutions. Accordingly, we include the indicator on public trust in politicians as a proxy for the general trust in formal institutions.

Whitley (1999) characterizes differences in employer-employee relations according to the distinction between paternalistic and formal cultures. Differences between the two essentially pertain to i) the scope of superior discretion, which is limited to the work context in formal cultures but which extends well into the personal sphere in paternalistic cultures, and ii) to whether subordinates can be entrusted with the responsibilities of decision-making. The implications of these differences extend to other characteristics of work relations, such as to the extent to which managerial decisions require further justification (Whitley, 1999) and the extent of post-employment care and benefits (Pellegrini and Scandura, 2008). Here, the nature of employer-employee relations, or rather the predominance of paternalism, is reflected in two related indicators (r = 0.61): the willingness to delegate authority to subordinates, and the extent to which management-worker relations are cooperative. The assumption is that in more paternalist cultures the willingness to delegate is lower, and that management-worker relations are less cooperative. Instead, in more formal political cultures, trust in subordinates is presumed to be higher, resulting in a higher willingness to delegate tasks and more cooperative superior-subordinate relations.

This association of paternalism with the readiness to delegate finds support in the recent international management literature on paternalistic leadership. What

3 This despite efforts since the late 1990s to propagate vocational training and to reduce the difference in status associated with general and vocational education paths (Bagnall, 2000).


58

paternalistic leadership entails, however, has become subject of debate; in particular the question whether paternalistic acts are performed with benevolent intent (Pellegrini and Scandura, 2008). Many—mostly western—authors tend to associate paternalism with patronizing and authoritarian leadership styles. Whitley (1999) for example characterizes paternalistic leadership styles by the tendency to “treat subordinates as children who cannot be expected to know their own best interests and act accordingly” (1999: 52). Others tend to describe paternalism as the personal concern and involvement with the well-being of subordinates which goes beyond the interests of the superior (Pellegrini and Scandura, 2006; Gelfand, Erez, & Aycan, 2007, Pasa, Kabasakal, and Bodur, 2001). But while there is debate over what leadership constructs are associated with paternalism, there appears to be agreement on the view that “[e]mployees in high-power distance cultures may expect the leader to take charge and give orders, rather than delegate decision-making authority to the subordinate” (Pellegrini and Scandura, 2006: 274). Both paternalism and the associated high power distance have been used to explain why delegation is not a universally accepted element of effective management (Pellegrini and Scandura, 2006; 2008), and our association of paternalism with the willingness to delegate therefore appears supported. Furthermore, the willingness to delegate authority to subordinates correlates strongly with the indicator on trust in politicians (r = 0.80). This correctly reflects the notion that in addition to situational factors, the structure of superior-subordinate work relations is strongly affected by the level of generalized trust (Payne and Clark, 2003).

All scores on the selected indicators identified above ranged between one and seven. We inverted the scores on union power for interpretive purposes. Cluster analysis We applied cluster analysis to our sample of OECD countries in order to assess the validity the selected institutional indicators. Cluster analysis is a statistical method used for the classification of empirical data on the basis of pre-defined cluster variables. Clusters are defined such that the within-group variance is minimized and between-group variance is maximized. Cluster analysis relies extensively on a researcher’s judgement, and hence the validity of obtained solutions are susceptible to critique (Ketchen and Shook, 1996). To obtain the best results we therefore largely follow the recommendations of Punj and Stewart (1983) and Ketchen and Shook (1996) by performing a two-stage clustering procedure, which increases the validity of the cluster solutions (Punj and Stewart, 1983). In the first stage, a hierarchical clustering method is used to identify the most suitable number of clusters. In the second stage, an iterative clustering method is used to derive the optimal clustering solution. The extent to which the results of the cluster analysis reproduce Whitley’s business system typology is a good indication of the validity of the selected indicators.


59

3.4 Results

The first step in our cluster analysis was to empirically determine the appropriate number of clusters. Using SPSS, we therefore first performed a hierarchical cluster analysis using Ward’s minimum variance method, based on squared Euclidean distance. Ward’s method is recommended when the cluster sizes are expected to be approximately equal, and when there are no outliers (Ketchen and Shook, 1996). We identified five clusters on the basis of the resulting dendrogram, and on the basis of our expectation that the fragmented business system type—largely reserved for countries with unreliable formal institutions (Whitley, 1999)—would not be present in our sample of OECD countries.

Next, we performed a K-Means cluster analysis to optimize the results. The resulting cluster centroids and country groupings are displayed in Tables 3.5 and 3.6. To see whether the obtained clusters were meaningful, we made our cluster scores comparable with Whitley’s (1999) characterization of the institutional features associated with the various business system types. The highest and lowest cluster centroids of each variable were labelled ‘high’ and ‘low’. Intermediate scores were labelled ‘limited’, ‘some’, and ‘considerable’, depending on their relative closeness to the highest and lowest scores. We averaged the labels of the institutional features for which we used two indicators. We then matched the identified clusters with business system types from Whitley’s (1999) comparative business systems framework; the results of which are presented in Table 3.7.

Table 3.5: Final cluster centres

Dimension Clusters

1 2 3 4 5

Independence of state policies 4.5 3.5 3.6 3.8 2.9

Subsidies promote competition 4.8 3.7 3.8 4.5 3.1

Pervasiveness of clusters 4.7 4.9 4.1 4.7 4.3

Market regulation 4.4 3.4 3.5 4.0 3.2

Access to stock market 5.9 5.2 5.1 5.2 4.5

Access to external finance 4.0 3.9 4.1 4.3 3.9

Difference in quality of schools 6.4 5.8 3.5 4.0 5.2

Union power 4.3 5.3 4.2 3.5 4.3

Trust of politicians 5.8 4.3 3.1 4.0 2.6

Management/worker relations 5.9 5.3 4.4 5.1 4.8

Delegation of authority 5.6 5.4 3.7 5.2 3.7


60

Table 3.6: Cluster membership a

Cluster 1 Cluster 4 Netherlands Iceland Denmark Luxembourg Switzerland Finland

United Kingdom Australia New Zealand United States Ireland

Cluster 2 Cluster 5 Sweden Austria Canada Belgium Germany Norway

Slovakia Czech Republic Italy Poland Japan

Cluster 3 Portugal Turkey Hungary Greece Spain Korea France Mexico

a Ranked according to distance to cluster centre.


61

Tab

le 3

.7: M

atch

ing

clus

ters

and

bus

ines

s sy

stem

s ty

pes

Inst

itut

iona

l fea

ture

s

C

lust

er 1

C

lust

er 2

C

olla

bora

tive

Clu

ster

3

Stat

e or

gani

zed

Clu

ster

4

Com

part

men

-ta

lized

C

lust

er 5

H

ighl

y co

ordi

nate

d C

oord

inat

ed

indu

stri

al d

istr

ict

The

sta

te

Stre

ngth

of s

tate

co

ordi

natio

n a

Low

C

onsi

dera

ble

Con

side

rabl

e C

onsi

dera

ble

Hig

h Li

mite

d Lo

w

Hig

h H

igh

Con

side

rabl

e lo

cally

Inco

rpor

atio

n of

in

term

edia

ries

C

onsi

dera

ble

Hig

h H

igh

Low

Lo

w

Con

side

rabl

e Lo

w

Lim

ited

Hig

h C

onsi

dera

ble

loca

lly

Stre

ngth

of m

arke

t re

gula

tion

Low

C

onsi

dera

ble

Hig

h So

me

Hig

h Li

mite

d Lo

w

Hig

h H

igh

Con

side

rabl

e lo

cally

Fina

ncia

l sys

tem

Cap

ital m

arke

t or

cred

it ba

sed

a M

ixed

C

redi

t to

Mix

ed

Cre

dit

Mix

ed

Cre

dit

Cap

ital m

arke

t C

apita

l mar

ket

Cre

dit

Cre

dit

Som

e lo

cal b

ank

risk

-sha

ring

Skill

dev

elop

men

t an

d co

ntro

l

Stre

ngth

of p

ublic

trai

ning

sy

stem

H

igh

Con

side

rabl

e H

igh

Low

Li

mite

d Li

mite

d Lo

w

Som

e Li

mite

d H

igh

Uni

on s

tren

gth

Som

e H

igh

Hig

h So

me

Low

Lo

w

Low

to s

ome

Som

e So

me

Hig

h

Tru

st a

nd a

utho

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3.5 Discussion

As Table 3.7 illustrates, clusters 2, 3, and 4 correspond closely with the collaborative, state organized, and compartmentalized business system types respectively. The most notable differences are that cluster 3 scores somewhat lower on both the strength of state coordination and the extent of market regulation, and higher on union strength than the state-organized ideal type. Cluster 4 displays slightly higher levels of state involvement than the compartmentalized business system type, and somewhat lower levels of trust in formal institutions. Cluster 5 corresponds reasonably well both with the highly coordinated and with the coordinated industrial district business system types. The main differences here are that cluster 5 scores markedly lower on the incor-poration of intermediaries than either the highly coordinated or the coordinated industrial district ideal type. Cluster 1, scoring low on direct state involvement and high on strength of the public training system and on trust in formal institutions, could not be clearly associated with any of the business system types of Whitley’s typology.

When we take cluster membership into consideration (Table 3.6), we see that the composition of the clusters generally corresponds with characterizations in the literature. The inclusion of both Germany and Sweden in cluster 2, which corresponds most closely with the collaborative business system type, is according to expectations (Whitley, 2000; Almond, Edwards, and Clark, 2003). Cluster 3 includes both France and South Korea, which in the literature are frequent examples of state organized economies (Whitley, 2000). Cluster 4, which corresponds most closely with the compartmentalized business system, only includes Anglo-Saxon countries, which is also in line with characterizations in the literature (Whitley, 2000). A notable exception to the group of Anglo-Saxon countries is Canada, which is included in the cluster corresponding most closely with the collaborative business system type (cluster 2). We see that Cluster 5 contains both Japan and Italy, which are generally associated with the highly coordinated (Whitley, 1994; Saka, 2004) and coordinated industrial district (Trigilia, 1990; Whitley, 1998) business systems respectively. This may suggest that these two business system types cannot be clearly distinguished based on the selected indicators. Alternatively, this may be due to the properties of the applied clustering method. For example, Ward’s clustering method, as used in the hierarchical cluster analysis, tends to produce comparatively similar-sized clusters.

The small open economies of Northern Europe emerge as a separate group in cluster 1. Both the results of the cluster analyses and the particular scores of cluster 1 suggest that this group of countries represents a distinctive business system type, characterized by low direct state involvement combined with high trust levels, the considerable incorporation of intermediaries, and a strong public training system. The institutional features of this cluster suggest strongly developed informal institutions,


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which may to some extent reflect pre-industrial values and relations, as suggested earlier for both the Netherlands (Van Iterson and Olie, 1992) and Denmark (Kristensen, 1996). The clustering of these countries in a separate group is noteworthy as it provides a counter-argument to suggestions that some of the smaller economies in northern Europe may be examples of hybrid business systems (e.g. Whitley, 2000), combining for example characteristics of the compartmentalized and collaborative ideal types. While this cluster indeed seems to share characteristics of both, the results of the cluster analysis suggest that the variation in institutional characteristics is systematic. This suggests that the institutional structuring of the countries in cluster 1 is both distinctive and coherent, rather than a combination of institutional features of countries with ostensibly more distinctive national business systems.

Overall, we see that the clusters formed on the basis of the selected institutional indicators correspond considerably well with Whitley’s business system typology. This lends support to our institutional indicators as well as to the distinctiveness of the business system types. What must be kept in mind is that Whitley characterizes ideal types, and that the institutional contexts of countries may naturally show some variation in their correspondence with such a theoretically defined typology. Given the relatively broad sample used here, covering four continents, we conclude that the outcome of the two-step cluster analysis lends sufficient support to our institutional indicators.

3.6 A measure of comparative institutional distance

The final step in the development of our measure of comparative institutional distance is the design of the actual measure. The key decision here is how the various institutional indicators should relate to each other, and how institutional distances between countries should be calculated based on the indicators at hand. We largely follow Kogut and Singh (1988) in the design of their widely applied measure of cultural distance based on Hofstede’s cultural dimensions (Hofstede, 1980), except for that we do not correct for differences in variance. As Kogut and Singh concur, correcting for variance imposes certain weights on the indicators included in a composite index. When the original scores are scaled similarly, as is the case in the Global Competitiveness Report, correcting for variance would inflate relatively small institutional differences between countries, while it would marginalize more considerable institutional differences. In such instances, the resulting institutional distances would be unnecessarily distorted. Ultimately, our measure of comparative institutional distance therefore takes the form of:

!

IDjk = (Iij " Iik )2/11

i=1

11

#


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where

!

IDjk is the institutional distance between countries j and k, and

!

(Iij " Iik ) is

the difference in scores of countries j and k on institutional feature i. The resulting institutional distances between the countries in our sample of OECD member states are included in Appendix B4.

3.7 Conclusion On the outset, the objective of this chapter was to develop and validate a measure of institutional distance which captures the qualitative institutional differences in economic organization between countries. Building on the comparative work of Richard Whitley (1999), we identified and validated appropriate institutional indicators which can be used in a composite index of comparative institutional distance. The results of the two-step cluster analysis largely replicated Whitley’s typology of business systems, which adds support to the selection of the institutional indicators.

The main contribution of this chapter is to address the under-representation of comparative historical institutional thought in currently available measures of institutional distance. It has been illustrated that for two out of three dominant strands of institutionalism in IB, namely new institutional economics and new organizational institutionalism, measures of institutional distance are available. Although the third strand of institutionalism, which Morgan and Kristensen (2006) labelled comparative historical institutionalism, has contributed significantly to our understanding of the effects of inherent institutional differences between societies on the nature of MNEs, it is poorly reflected in quantitative studies in IB due to the lack of a measure of comparative institutional distance. The measure proposed in this chapter may help address the lack of comparative historical thought in quantitative analyses.

The second contribution of this study is in that, to the best of our knowledge, this is the first study to provide quantitative support for the distinctiveness of several of the business system types that make up the business systems framework (Whitley, 1992; 1999). As indicated earlier, the business systems framework emerged from detailed but relatively particularistic socio-economic accounts and comparisons of both Asian and European market economies (e.g. Hamilton and Biggart, 1988; Van Iterson and Olie, 1992; Redding, 1990) rather than from the systematic comparison of

4 Both the institutional distance indicator developed here and the cultural distance index by Kogut and Singh (1988) are based on (averaged) squared Euclidean distances. This method imposes progressively greater weight on objects (e.g. countries) that are more different. Appendix C contains the institutional distances which result when (standard) Euclidean distances are calculated.


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a wide set of countries from the outset. This makes the business systems framework susceptible to criticism that the ideal types reflect idiosyncrasies of the countries considered—such as Japan and Korea—rather than of aggregated business system types. The results of the cluster analysis clearly suggest that Whitley’s characterization holds even when a wider set of developed economies is considered.

A third contribution of this study is in the identification of an unnamed yet distinctive business system type which appears characteristic of some of the small open economies of Northern Europe. In particular, this group of countries displays relatively low direct state involvement, combined with high trust levels, the considerable incorporation of intermediaries, and a strong public training system. While the institutional characteristics of these economies show similarities with several other business system types, such as with the collaborative and compartmentalized ideal types, the results of the cluster analyses suggest that the variation in institutional features is systematic. This suggests that the business systems framework may have to be complemented with a more consociational business system type, where the diverse interests of economic actors are reconciled through inclusion and coordinated on the basis of strong informal institutions.

However, the indicators incorporated into our measure of institutional distance are proxies rather than direct measures of the key institutional elements identified by Whitley. As such, one may argue that public trust in politicians does not fully reflect the trust of the public in formal institutions, or that the difference in the quality of schools available to rich and poor children does not correspond fully with the over-all strength of the public training system. Yet, for the calculation of a measure of institutional distance, such proxies do suffice as long as the variation on the indicators used corresponds sufficiently with the variation in institutional characteristics (see Cronbach, 1971). The results of the two-step cluster analysis demonstrate that on the basis of the indicators used in our measure of institutional distance, Whitley’s business system typology can be reproduced, which builds a strong case for the appropriateness of these indicators. Another potential limitation is that we were unable to identify appropriate indicators for three institutional characteristics: the dominant organizing principle of unions, the extent to which bargaining is centralized, and the extent to which communal norms govern authority relations. Possibly as a result of this, we were unable to distinguish between the highly coordinated and the coordinated industrial cluster business system types, although alternative explanations should also be considered. For example, the share of countries in our sample which have been characterized as dominated by coordinated industrial clusters is relatively small. A close inspection of the calculated distances between the countries in our sample (see Appendix B) learns that the omission of these institutional features does not result in counter-intuitive institutional distances.


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Paradoxically, perhaps the most important limitation of our institutional indicator is that essentially, the idea of capturing inherent institutional country differences in a single measure of institutional distance runs counter to the very idea of comparative institutionalism with its emphasis on thick description. But does that imply that we should leave out and ignore inherent institutional country differences from quantitative analyses altogether? The central gist of this chapter has been that if we are to include country variables on inherent differences into our analyses, then at least let us include indicators which have some theoretical substance, and which have been proven to correspond at least reasonably well with the theoretically and empirically expected variation in institutional characteristics. We recommend the use of our indicator of comparative institutional distance in the quantitative analysis of IB phenomena where inherent country-level differences may potentially matter. Examples are studies on subjects where the effects of national cultural differences have traditionally been considered, such as in studies on internationalization sequence, subsidiary performance, or international joint venture dissolution. We imagine that comparative institutional distance can also be employed as an alternative or complement to economic institutional distance indicators in the analysis of e.g. location decisions (cf. Treviño and Mixon, 2004) or entry and establishment mode selection (cf. Meyer, 2001; Dikova and Van Witteloostuijn, 2007). Finally, we recommend the use of comparative institutional distance as an alternative to organizational institutional distance (Kostova, 1997; Kostova and Roth, 2002) in studies where the level of analysis does not easily allow for the decomposition of the institutional environment into distinctive regulative, normative, and cultural-cognitive components. Attempts to include narrowly compiled cognitive institutional profiles in the analysis of IB phenomena which transcend single cognitive domains occurs far too often.

Chapter 4

The familiarity dimension of psychic distance—Or, why historical ties affect the location of foreign investment!

4.1 Introduction

International business studies often apply the concept of psychic distance to explain foreign market selection (Dow, 2000; Ellis, 2007; Stöttinger and Schlegelmilch, 1998) or international organizational performance (Evans and Mavondo, 2002; Evans, Treadgold, and Mavondo, 2000; O’Grady and Lane, 1996). Although actual measures of psychic distance have proved problematic (Dow, 2000; Dow and Karunaratna, 2006), a common assumption implies that the psychic distance experienced toward a foreign market depends on the extent to which the foreign host country differs from the home country. Country differences, such as in culture, religion, and political systems, should disturb the flow of information from the foreign market to the firm, which limits a firm’s ability to learn about such markets (Johanson and Vahlne, 1990; Johanson and Wiedersheim-Paul, 1975). All else being equal then, firms can be expected to favour foreign markets in countries that are more similar to their home country.

Despite significant progress in operationalizing various psychic distance stimuli (Brewer, 2007; Dow and Karunaratna, 2006), the predominant focus on country differences and actual knowledge may overlook an important dimension of psychic distance. In particular, we argue that what determines the perception of psychic distance, and subsequently foreign market selection, is not merely the degree of similarity between the home and the foreign country but also the extent to which a foreign market environment is perceived as familiar. The familiarity argument

! This chapter draws upon a paper co-authored by Jutta Bolt. Her contribution to this study is gratefully acknowledged.


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developed in this chapter builds on the idea that the perceived understanding of foreign markets depends not only on actual knowledge and market information (cf. Brewer, 2007; Johanson and Wiedersheim-Paul, 1975) but also on the unsubstantiated beliefs, assumptions, and generalizations that are held to be true regarding the nature of a foreign market environment and the wider institutional context. As a result, foreign markets may be perceived as psychologically close despite a lack of actual knowledge, or despite actual differences between countries.

We explore the validity of this argument by examining the extent to which both country differences and historical ties—a variable we associate with the perception of familiarity—affect the location of foreign direct investment (FDI) originating from the United Kingdom, France, the Netherlands, and Germany between 1984 and 2003. Historical ties, common language, and the level of industrial development all significantly affect the location of foreign investment, but we find no consistent support for the idea that firms favour investments in countries that are more similar in terms of culture, institutional environment, religion, political system, or education level.

The results thus caution against the indiscriminate use of country differences in conceptualizations and operationalizations of psychic distance. As others have argued and illustrated (e.g., Dow and Karunaratna, 2006; Evans and Mavondo, 2002), not all country similarities have equal weight as psychic distance stimuli. In addition, the results provide partial support for the argument that in addition to its relation to the similarities between the home and the host country, psychic distance relates inversely to perceptions of familiarity with a foreign country or market.

The results also require two caveats. First, the use of aggregate data prevents us from examining the effects of historical ties on the actual internationalization sequence of firms or the commitment of resources over time. Second, the historical tie variable is but one of many potential indicators of foreign market familiarity, and it correlates with another explanatory variable, common language. We nonetheless focus on historical ties, which appear in previous literature as a potential psychic distance stimulus (e.g., Brewer, 2007; Dow and Karunaratna, 2006). Despite these concerns, the results open new lines of inquiry into the psychological dynamics of decision makers involved in internationalization decisions.

The remainder of this chapter proceeds as follows: We first critically review existing literature on psychic distance. Motivated by mixed empirical support and conceptual issues, we develop the notion of familiarity as an additional dimension of psychic distance. Then, following a discussion on the use of historical ties as a country-level indicator of perceived familiarity, we discuss the research methods and analysis results. We end with a discussion of the potential implications of the familiarity construct for the psychic distance concept, as well as for internationalization process theory at large.

Chapter 4: The Familiarity Dimension of Psychic Distance

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4.2 Psychic distance and the location of foreign investment

The term “psychic distance,” initially coined in a study on Western European trade patterns by Beckerman (1956), entered the field of international business studies in the 1970s with the development of internationalization process theory, which predicts two distinct patterns: the development of a firm’s engagement within foreign markets and the selection of foreign markets (Johanson and Vahlne, 1990).

Within foreign markets, internationalization process theory argues that a lack of local market knowledge initially defers resource commitments. Over time, however, greater market-specific knowledge should result in a gradual increase in foreign market involvement through more committed modes of operation and larger resource commitments—a phenomenon termed the “establishment chain” (Johanson and Wiedersheim-Paul, 1975). According to O’Grady and Lane (1996), the establishment chain therefore reflects a gradual ‘learning through experience’ process within countries.

Regarding the selection of foreign markets, internationalization process theory predicts that “firms enter new markets with successively greater psychic distance,” which results from the degree of dissimilarity between markets, such as “differences in language, culture, political systems, etc.” (Johanson and Vahlne, 1990: 13). As O’Grady and Lane (1996: 310) explain, “[t]here is an implicit assumption that psychically close countries are more similar, and that similarity is easier for firms to manage than dissimilarity, thereby making it more likely that they will succeed in similar markets.” As a result, International Business literature largely assumes that country differences represent the source of psychic distance.

This emphasis on country differences, and cultural differences in particular, increased in response to the growing conception that cultural and psychic distance relate closely, as well as due to the availability of relatively straightforward measures of cultural distance. Kogut and Singh (1988), in their study of the influence of cultural distance on entry mode selection, claim that “[c]ultural distance is, in most respects, similar to the ‘psychic distance’ used by the Uppsala school” (1988: 430). Their study popularized the use of a convenient measure of cultural distance based on Hofstede’s (1980) work, which in turn facilitated the interchangeable use of cultural and psychic distance. Furthermore, in their discussion of the Uppsala model, Johanson and Vahlne (1990) explain that “[t]he internationalization model predicts, taking only psychic distance into account, that firms will start by invading ‘neighbouring’ (in the cultural sense) markets and later, as experience grows, more distant markets will be entered” (1990: 17). Here, Johanson and Vahlne explicitly link psychic distance to cultural closeness, unintentionally further obscuring the difference between the two concepts.

In response to the growing convergence between psychic and cultural distance, from the mid-1990s onward, several pleas demanded a more elaborate


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operationalization of psychic distance (e.g., Evans, Treadgold, and Mavondo, 2000; Harzing, 2003; O’Grady and Lane, 1996; Stöttinger and Schlegelmilch, 1998). On the one hand, some authors suggest expanding the measure of psychic distance by including additional measures of country differences, such as differences in language (Harzing, 2003), industry structure (O’Grady and Lane, 1996), or legal and administrative approaches (Harzing, 2003). On the other hand, researchers also suggest psychic distance measures based on perceived rather than objective country differences (e.g. Dow, 2000; Evans, Treadgold, and Mavondo, 2000; Harzing, 2003; O’Grady and Lane, 1996), such as psychic distance measures based on expert panels (Dow, 2000; Ellis, 2007; Nordström, 1991), psychographic instruments (O’Grady and Lane, 1996), and large-scale questionnaires (Stöttinger and Schlegelmilch, 1998).

More recently, the presumed effects of country differences have become subjects of debate. In a critical review, Shenkar (2001) extensively discusses several conceptual illusions and methodological assumptions regarding cultural distance, and Harzing (2003) questions the explanatory power of cultural distance in FDI decisions, particularly regarding entry mode selection and performance evaluation. The presumed influence of cultural distance on FDI decisions may have been overestimated, and country-specific characteristics may hold much more power in explaining foreign investment decisions. In a similar vein, Brewer (2007) proposes extending measures of psychic distance with indicators other than country differences, such as the availability of secondary information about foreign markets or the value of foreign aid programmes.

As discussed in Chapter 1, empirical studies considering the effects of both cultural and psychic distance on market selection and expansion patterns have produced mixed results. Regarding cultural distance, Erramilli (1991) suggests that increases in firm experience abroad, measured as geographic scope, result in the selection of culturally more distant markets. Along similar lines, Grosse and Goldberg (1991) and Grosse and Trevino (1996) find that cultural distance negatively affects the direct involvement of firms in the United States, in terms of both assets and offices (Grosse and Goldberg, 1991) and FDI (Grosse and Trevino, 1996). Yet studies by Engwall and Wallenstål (1990), Benito and Gripsrud (1992), Mitra and Golder (2002), and Ellis (2007) find no support for the idea that firms gradually expand into culturally more distant countries. Rather, Mitra and Golder (2002) and Ellis (2007) suggest that firms tend to enter markets that are similar to previously entered markets rather than to the home market.

Studies on the effect of psychic distance also produce mixed results. For example, Dow (2000) finds that psychic distance, measured using a panel of experts, significantly affects the pattern of export market selection by Australian exporters. In contrast, Ellis (2007), using a similar method, finds no direct effect of psychic distance on foreign market entry. In their exploration of potential country-level psychic distance stimuli, Dow and Karunaratna (2006) find that differences in education levels


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and religion in particular affect the intensity of bilateral trade in their sample. Yet Stöttinger and Schlegelmilch (1998: 367) reveal no effect of psychic distance on export development and therefore suggest that “the concept of psychic distance has ‘past [sic] its due-date’.”

Familiarity The lack of consistent empirical support for the psychic distance construct may result from a misconception about what causes decision makers to perceive some countries as psychologically more distant than others. Recent studies focus on refining the concept by expanding the measurement of psychic distance in operational terms (Brewer, 2007; Dow and Karunaratna, 2006), but we contend that the psychic distance construct requires reconsideration at the conceptual level, especially with regard to the role of country differences as the sole driver of psychic distance.

Internationalization process theory employs the psychic distance construct as the cognitive link between the foreign market and the uncertainty that decision makers experience toward that market (Johanson and Vahlne, 1977). This uncertainty relates to characteristics of the foreign market environment, because country differences “disturb the flow of information between the firm and the market” (Johanson and Vahlne, 1990: 13), which hampers the development of local knowledge. Psychologically more distant countries thus should be less easy to understand, and following the logic of uncertainty reduction, firms should prefer the commitment of resources to markets that are more similar to the home country.

What remains underemphasized, however, is that psychic distance is a cognitive phenomenon, based on both knowledge and beliefs. Internationalization process theory overlooks that implicit beliefs and assumptions about the nature of a foreign market may drastically reduce the uncertainty associated with resource commitments, even when the decision maker lacks knowledge and actual differences exists between countries. In other words, the more we know or think we know about a country, the less uncertainty we experience as a result of our (presumed) lack of local knowledge.

Accordingly, the psychological distance that decision makers experience toward a foreign country may stem not only from actual knowledge or information flows but also from the perception of familiarity with a foreign market, which results from beliefs and assumptions that a decision maker holds to be true. Subjective beliefs and assumptions differ from actual knowledge; whereas “[k]nowledge is generally defined as a subset of beliefs […] beliefs do not have to be justified or true to affect decisions” (Markóczy, 1997: 1230). Thus, the perception of psychic distance should stem from the lack of both actual knowledge and subjective beliefs about a foreign market.

We find a somewhat similar argument in Beckerman (1956), who, in coining the term psychic distance, in our reading refers to the perception of familiarity with a country rather than an inhibitor of information flows. Beckerman (1956: 38) suggests


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that psychic distance stems from both “the extent to which foreign sources have been personally contacted and cultivated” and the nearness of a foreign market resulting from a “psychic evaluation” by an individual. Although Beckerman briefly refers to linguistic similarities, country differences are not central in his notion of psychic distance. Rather, he alludes to the extent to which a foreign country is perceived as familiar, as a result of both personal experience and mental representations.

The familiarity argument in turn suggests that the degree of psychic distance depends not on country differences alone but on other factors that affect the knowledge decision makers have and the beliefs they hold. The question of which factors affect the representation of a particular information environment in the knowledge structure of decision makers typically appears in research on managerial and organizational cognition. For example, an extensive review of cognitive work in organizational decision making (Walsh, 1995) illustrates the complexity of understanding the origins of knowledge structures, in that factors at the individual, group, organizational, and national level all likely play a role. Direct personal experience and formal education, as well as socialization processes among the family (Gibson and Papa, 2000) and at the organizational level (Van Maanen and Schein, 1979), represent just some of the factors that shape decision makers’ knowledge structures. Furthermore, research into the determinants of national stereotypes suggests that beliefs about foreign nationals form in response to media coverage and cultural exports (Eagly and Kite, 1987). Overall, these studies indicate that perception links invariably to the cognitive structure of the observer, which in turn depends on many potential information sources. Regardless of whether decision makers perceive countries as more or less similar, their knowledge and strong beliefs about the nature of those foreign countries and markets affect their perception of familiarity, which should lower the psychological distance they experience.

The term “familiarity” is not new to the international business literature. For instance, Child, Ng, and Wong (2002: 50) expect less psychic distance between the United Kingdom and Hong Kong due to “a degree of mutual familiarity arising from the fact that Hong Kong was a British colony until 1997.” Yet little consensus indicates what familiarity actually implies, and the term is often applied without further elaboration. It has been equated with geographical proximity (Weinstein, 1977) and cultural distance (Erramilli, 1991) and associated with the liability of foreignness (Pedersen and Petersen, 2004; Zaheer, 1995), foreign market knowledge (Pedersen and Petersen, 2004), and information flows (Brewer, 2007). Both Pedersen and Petersen (2004) and Brewer (2007) associate familiarity with psychic distance, but equating familiarity—and psychic distance—with foreign market knowledge alone, as Pedersen and Petersen (2004) do, may ignore the crucial point that perceptions of familiarity stem from (unjustified) beliefs as well. And although we agree with Brewer’s (2007) assertion that measuring perceived differences alone cannot suffice


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for operationalizing psychic distance, we propose widening the very notion of what constitutes psychic distance, not just the range of indicators used to measure it.

Furthermore, our argument demands differentiation between familiarity and experience. The perceived familiarity that we associate with psychic distance differs from firm experience, in that experience relates to post-entry learning about foreign markets (Johanson and Vahlne, 1977, 1990). Perceptions of familiarity instead relate to the psychic distance experienced both before and after entry. Therefore, though country-specific corporate experience may explain subsequent increases in resource commitments in a particular market (Davidson, 1980), it holds no explanatory power ex ante.

Familiarity and historical ties Historical ties do not directly refer to country differences but nonetheless often appear associated with reduced psychic distance. Both Brewer (2007) and Dow and Karunaratna (2006) include colonial ties in their efforts to expand and improve the measures used to operationalize psychic distance, and Child, Ng, and Wong (2002) suggest the short psychic distance between Hong Kong and the United Kingdom results from their historical ties; a claim supported by Ellis (2007), whose psychic distance scores for Hong Kong places the United Kingdom between Thailand and Korea. There are subtle differences in the way historical ties have been argued to affect the perception of psychic distance. Whereas Child, Ng, and Wong (2002) and Dow and Karunaratna (2006) expect historical ties to affect perceptions of psychic distance indirectly, by engendering institutional or political and linguistic similarities, Brewer (2007) argues that they result in more detailed knowledge of these countries, which affects the perception of psychic distance directly.

Instead, we consider a historical tie a country-level psychic distance stimulus that positively affects perceptions of familiarity with a particular country by fostering more or less collectively shared beliefs about that country. The exact ways historical ties affect the knowledge structure of a population are complex. For example, postcolonial critics such as Edward Said (1978) note that colonial ties are often reflected in the national education systems and literary histories of the colonizers, which sustains particular representations of these countries in collective knowledge structures. Similarly, historical ties may foster stereotypical beliefs about foreign nationals (e.g., the Irish as excessive drinkers; Greenslade, Pearson, and Madden, 1995), which are not necessarily shared by the inhabitants of countries without such a historical tie. More direct effects of historical ties are conceivable, such as the presence of certain ethnic minorities or the incorporation of foreign dishes into the national cuisine of a country, which likely shape the mental representation of foreign nationals and foreign contexts further. In short, we argue that both directly and indirectly, historical ties evoke particular shared beliefs about the nature of a foreign country and its nationals,


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which increases the extent to which a country may be perceived as familiar. Following our familiarity argument, we expect historical ties to reduce the psychological distance experienced by key decision makers and positively affect location decisions.

Will all historical ties, both positive and negative, positively affect location decisions? It can be argued that historical ties with a negative connotation deter investments due to negative sentiments, but we separate the perception of familiarity that results from a historical tie from the emotional connotation of that historical tie. That is, we assume that irrespective of the connotation, historical ties positively affect the perception of familiarity, and psychological distance therefore decreases.

We explore the validity of our argument by examining the effect of historical ties on the location of FDI.1 In line with our familiarity argument, we expect the following effect of historical ties on the location of foreign investment:

Hypothesis: A historical tie between the home and the host country has a positive effect on the amount of foreign direct investment from the home country dedicated to the host country.

Our familiarity argument and the country differences identified in existing literature offer alternative, and potentially complementary, explanations of what drives psychic distance. We therefore also include several measures of country differences in our em-pirical analysis as control variables, relying primarily on work by Johanson and Wiedersheim-Paul (1975), Johanson and Vahlne (1977, 1990), and Dow and Karunaratna (2006) to select among the many country differences available in the literature.

Specifically, we include differences in culture (Johanson and Vahlne, 1977; 1990; Johanson and Wiedersheim-Paul, 1975), institutionalized business practices (Johanson and Vahlne, 1977), and language (Johanson and Vahlne, 1977; 1990; Johanson and Wiedersheim-Paul, 1975). In addition, we include differences in education level and industrial development, as suggested by Johanson and Vahlne (1977) and Johanson and Wiedersheim-Paul (1975). Both Johanson and Vahlne (1990) and Johanson and Wiedersheim-Paul (1975) also note the potential relevance of religious and political system differences, distinguishing between ideological

1 Although colonial ties may represent a determinant of foreign trade (Frankel and Rose, 2002; Linnemann, 1966; Rauch, 1999; Tinbergen, 1962), the potential effect of historical ties on the location of foreign investment remains largely overlooked. Studies on foreign investment that consider historical ties generally interpret them as indicators of either cultural or institutional distance, rather than as an explanatory variable. Rauch (1999) and Wei (2000), for example, combine colonial ties and common language in a composite variable to proxy for cultural distance, and Head and Ries (2005) combine historical ties and geographical distance.


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differences and differences in political freedom (Dow and Karunaratna, 2006). We therefore also control for differences in political ideology, democracy, and religion.2

4.3 Data and methods

Our empirical analysis focuses on the influence of historical ties and country similarities on the location of FDI, for which we use an adjusted gravity model. We do not seek to explain the location of foreign investment in full, nor measure or operationalize psychic distance directly. Rather, we seek to challenge the assumption that psychic distance stems solely from country differences by contrasting the effects of country similarities with that of a country-level antecedent of perceived familiarity (historical ties) on the location of foreign investment. As Dow and Karunaratna (2006) explain, the use of data pertaining to aggregate firm behaviour is appropriate when the explanatory variables are country-level measures, which involves matching the level of analysis of the dependent and independent variables.

We address the location of FDI from four source countries: the United Kingdom, France, the Netherlands, and Germany. All four source countries are major international investors. Three of the four have been major colonial powers at some point in time, and Germany maintains historical ties with a substantial number of countries within Europe. By focusing on four source countries from the EU, we control for the effects of preferential trade agreements between host countries and former colonizers. That is, the EU’s common border policy applies preferential trade agreements to both the former colonizer and the EU as a whole, which nullifies any advantages of former colonizers over other EU members.

The gravity model The empirically most successful framework for predicting foreign trade flows is the gravity model (Anderson and Van Wincoop, 2003; Bloningen and Wang, 2004; Rauch, 1999). Gravity equations are increasingly applied to explain cross-border investments, such as FDI flows (Anderson and Van Wincoop, 2003) and FDI stock (Head and Ries, 2008; Wei, 2000). The basic prediction of the gravity model is that “the volume of trade between two countries will be directly proportional to the product of their economic masses (as measured using GDP or GNP) and inversely proportional to the distance between them” (Rauch, 1999: 10). The basic gravity model can be expressed as:

!

Tradeij = "0*GDPi

"1*GDPj

" 2*Dij

" 3, (1)

2 Because Dow and Karunaratna (2006) find that the effect of time zones is neither strongly nor consistently significant, we exclude this factor.


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where Tradeij is the bilateral trade between source country i and host country j; GDPi and GDPj are the gross domestic products of country i and j, respectively; and Dij is the weighted geographical distance between source country i and host country j.

Linearizing equation (1) and substituting FDI for trade, we derive the following gravity equation:

!

ln(1+ FDIij ) = "0 + ("1 + "2) * ln(GDPiGDPj )

+"3 * lnDij + "4 * Xij + #ij , (2)

where FDIij is the bilateral stock of outward FDI of source country i in host country j, ln(GDPiGDPj) is the product of the size of the economies of the host and source country, and lnDij is the log of the weighted distance between the source and the host country. In addition, Xij is a vector that includes bilateral familiarity and similarity variables, and !ij is the error term. Because our four source countries report zero stock of outward FDI for various countries, using the double log form of the gravity equation would cause the loss of potentially valuable information. We therefore use ln(1 + FDIij) as the dependent variable, following Eichengreen and Irwin (1995) and others. The sample is (again) truncated at zero, so we estimate the equation using a Tobit rather than an ordinary least squares procedure.

FDI data As our dependent variable, we use the bilateral stock of outward FDI of the four source countries by geographical destination between 1984 and 2003. Although using FDI flows may appear more appropriate when analyzing location decisions, FDI flow statistics do not account for multinational enterprise (MNE) activities financed through local capital markets (Devereux and Griffith, 2002), such as setting up a foreign subsidiary with local capital. In addition, outward FDI flow data often contain disinvestments from the host country, which explains their frequent negative values (OECD, 2008). Therefore, we use FDI stock as a closer approximation of the actual location of MNE activity.

We use Source OECD and UNCTAD data about outward FDI stock, complemented with data provided by the Office for National Statistics (U.K.) and the central banks of Germany, France, and the Netherlands. To convert national currencies into U.S. dollars, we multiply data reported in national currencies by the currency ratios provided by the OECD.

Data pertaining to FDI stock in non-OECD countries is not always consistently reported annually, so we average the reported values for four five-year periods: from 1983–1988, 1989–1993, 1994–1998, and 1999–2003. This approach has two additional


77

advantages. First, it enables us to include a more extensive set of independent variables, based on data from the 1990s, in our analysis of the last time period. Inversely, it prevents an explanation of the location of FDI in the first three time periods that uses variables based on future data. Second, testing our models for four separate time periods enables us to assess the robustness of our estimations against temporal trends in foreign investment, such as the rise of China as a major recipient of FDI.

Independent variables Along with the average bilateral stock of outward FDI in the four five-year periods as our dependent variable, we include the following independent variables.

National incomes. The most commonly identified determinant of foreign investment is the market size (measured as national income, or GDP) of both the host and the home country. Our equation includes the market sizes at the beginning of each five-year period in constant 2000 U.S. dollars, as reported by the World Bank World Development Indicators.

Geographic distance. The geographic distance between the source and the host countries, taken from the CEPII data set3, equals the weighted bilateral distance between the largest cities of the source and target country in kilometres, weighted by the share of the city in the overall population of the country. We expect an ambiguous effect, because greater distance is associated both with more FDI, to circumvent the transportation costs of exports (Egger and Pfaffermayer, 2004), and less FDI, because the costs of monitoring increase with distance (Head and Ries, 2005).

Several variables included in the vector Xij represent various potential psychic distance stimuli. In addition to historical ties, our familiarity-based psychic distance stimulus, we include common language and seven measures of country differences.

Historical ties. We presume a historical tie exists between a host and a source country when substantial parts of both have existed under common rule for a substantial period of time. We define a substantial part of a host country as one-third of the geographical area or one-third of the population. With regard to a substantial period of time, we use one generation, which corresponds to 30 years of common rule. Key to our definition of a historical tie is that a certain degree of historical familiarization must be assumed to have taken place. We include historical ties starting with the coronation of Otto I in 962, which marks the formation of the Holy Roman Empire and the unification of several Central European fiefdoms. Data on colonial ties come from Henige (1970), and data on historical ties within Europe derive from Davies (1996) and Bideleux and Jeffries (2002).

3 The CEPII data set was obtained from http://www.cepii.fr/anglaisgraph/bdd/distances.htm.


78

Common language. A host and a source country share a common language when the official language of the source country is an official language in the host country. The CEPII data set provide data about common languages.

Cultural distance. Due to the pervasiveness of the concept in the international business literature and the common notion that cultural similarities between the host and the source country affect the location of foreign investment, we include a measure of bilateral cultural distance. Specifically, we adopt the most common measure of cultural distance, based on Hofstede’s (1980) indices, as suggested by Kogut and Singh (1988):

!

CDst = {(Iis " Iij )2/Vi}

t=1

4

# / 4 ,

where CDst is the cultural distance between source country s and target country t, (Iis-Iit) is the difference in scores of countries s and t on characteristic i, and Vi is the variance on characteristic i.4 Because we estimate a double log form of the gravity model, we use the log of cultural distance in our equation.

Institutional distance. Measures of institutional distance, as developed by Kostova and others (Busenitz, Gómez, and Spencer, 2000; Kostova, 1997, 1999; Kostova and Roth, 2002), rely on the decomposition of the institutional environment into regulative, normative, and cognitive components. Such institutional profiles can be compiled only with respect to very specific domains, such as the legitimacy of a particular organizational practice, which resides at a much lower level of analysis than that of our study. To capture relevant country-level institutional differences and similarities, we therefore apply the measure of institutional distance developed in Chapter 3, which is based on the key country-level institutional features identified by Whitley (1999). We calculate institutional distance in a manner similar to the cultural distance index proposed by Kogut and Singh (1988) but without correcting for differences in variance,5 which takes the form:

!

IDjk = (Iij " Iik )2/11

i=1

11

# ,

where IDst is the institutional distance between source country s and target country t, and (Iis-Iit) is the difference in the scores of countries s and t on institutional feature i. To compare the estimated coefficients with those of the other variables, we use the log of institutional distance in our equation.

4 The original measure of cultural distance, provided by Kogut and Singh (1988), distinguishes between Hofstede’s scores for the United States (u) and the included foreign countries (j). 5 As Kogut and Singh (1988) concur, correcting for variance imposes certain weights on the indicators included in a composite index. When the original scores are scaled similarly, as is the case in the Global Competitiveness Report, correcting for variance would inflate relatively small differences on some indicators and marginalize more considerable differences in country scores on other indicators. This would unnecessarily distort the resulting institutional distances.


79

Furthermore, we adopt five composite variables pertaining to country differences from Dow and Karunaratna (2006).

Education. Dow and Karunaratna (2006) calculate the difference in education levels by first calculating the differences in adult literacy and enrolment rates in both secondary and tertiary education for the population over 15 years. Subsequently, they apply factor analysis to combine the three scores into a single difference variable, then take the absolute value.

Democracy. Country-level differences in the degree of democracy reflect the mean scores of four different democracy variables, taken from the POLCON V, the (modified) POLITY IV, the Freedom House Political Rights, and the Freedom House Civil Liberties database between 1993 and 1998. Dow and Karunaratna (2006) first calculate country differences for each score, then combine the scores using factor analysis to derive the absolute values.

Industrial development. Industrial development depends on income levels, energy consumption, the percentage of the labour force not working in agriculture, urbanisation, and the number of passenger cars, newspaper circulation, radios, telephones, and televisions per 1000 inhabitants. All data refer to 1994, except for the literacy rate, which has values for 1995. Dow and Karunaratna (2006) calculate the country differences for each variable, combine them into a single variable using factor analysis, and use the absolute differences.

Political ideology. Scores of different political ideologies come from Beck and colleagues (2001), measured between 1993 and 1998, and indicate absolute differences.

Religion. To measure differences in major religions between countries, we first assign scores to the distance between the two closest major religions between countries, ranging from those of the same denomination or sect to those that belong to different religious families. Subsequently, we assign scores to the prevalence of a country’s major religion in the other country, and vice versa. Factor analysis enables us to combine the differences between these scores. Data come from Dow and Karunaratna (2006) and date from 2000.

4.4 Results

In Table 4.1, we present the descriptive statistics and the correlation matrix for the most recent time period (1999–2003). The results of the Tobit estimations for 1999 to 2003 appear in Table 4.2, whereas Appendix D contains the correlation tables and results for the earlier periods. Correlations remain stable across the four time periods. As Table 4.1 shows, the dummies for historical ties and common language are moderately correlated (r! = 0.60); therefore, we do not include historical ties and common language in the same equation. Neither dummy correlates strongly with any of the other similarity-based variables. As expected (Dow and Karunaratna, 2006), the


80

democracy, education, and industrial development variables show signs of multicollinearity, especially between education and industrial development (r = 0.77). The rest of the correlation matrix does not suggest any clear incidences of multicollinearity, but we test for it by estimating auxiliary regressions involving only independent variables. Cultural and institutional distance and, to a lesser extent, cultural distance and the dummy for language correlate mildly. Including these variables together may result in biased estimates.

Model 1 (Table 4.2) provides the results from the basic gravity model that includes market size and geographical distance. In model 2, we add the historical tie dummy. The coefficient of historical ties is significant (p < 0.001), with the expected positive sign, and increases the explanatory power of the model. This result is consistent with our findings for the earlier time periods (Appendix D). In the subsequent models (models 3–10), we estimate the isolated effects of the control variables and find that the coefficients of both cultural distance (model 3) and institutional distance (model 4) are significant (p < 0.05), with the expected negative signs. In model 5, we estimate the effect of common language in isolation. Similar to historical ties, the coefficient is strongly significant (p < 0.001) and displays the expected positive sign. The results for cultural distance and common language also are consistent with our results for earlier time periods (Appendix D). In models 6–10, we estimate the effects of the similarity variables adopted from Dow and Karunaratna (2006); differences in democracy (p < 0.10), education level (p < 0.10), and the level of industrial development (p<0.001) all appear to have a negative effect on the location of foreign investment in isolation. However, we find no significant effects of differences in political ideology (model 9) or religion (model 10).

In models 11–16, we estimate the combined effects of cultural and institutional distance with historical ties and common language, respectively. When we consider the effect of cultural distance in combination with historical ties (model 11) and common language (model 14), the coefficient of cultural distance shows the expected sign, but the effect is not significant. Both the effects of historical ties and common language remain strongly significant, and the coefficients show the expected sign. We find similar results for the earlier time periods (Appendix D); the effect of cultural distance weakens or disappears when combined with either historical ties or common language, which both remain strongly significant. Furthermore, the coefficient of institutional distance remains significant when considered with both historical ties (model 12, p < 0.05) and common language (model 15, p < 0.10). When we contrast the effects of historical ties and common language with both cultural and institutional distance (models 13 and 16), the coefficients for both cultural and institutional distance exhibit the expected sign but are not significant. The coefficient of both historical ties and common language remains strongly significant (p < 0.01 and p < 0.001, respectively).


81

T

able

4.1

: Des

crip

tive

sta

tist

ics

and

corr

elat

ions

199

9–20

03

Var

iabl

es

N

Mea

n s.d

. 1

2 3

4 5

7 8

9 10

11

12

1. F

DI 1

999-

2003

17

1 7.

68

2.11

2. N

atio

nal i

ncom

es 1

999

171

26.0

6 1.

52

0.69

**

3. D

istan

ce

171

8.11

1.

17

-0.5

3**

-0.2

2**

4. H

istor

ical

ties

17

1 0.

13

0.34

0.

33**

0.

19*

-0.1

8*

5. C

omm

on la

ngua

ge

171

0.09

0.

29

0.25

**

0.04

-0

.10

0.60

**

7. C

ultu

ral d

istan

ce

171

0.37

0.

91

-0.3

6**

-0.2

6**

0.27

**

-0.2

5**

-0.3

3**

8. In

stitu

tiona

l dist

ance

17

1 0.

37

0.67

-0

.46*

* -0

.37*

* 0.

34**

-0

.22*

* -0

.19*

0.

42**

9. D

emoc

racy

17

1 0.

31

0.38

-0

.27*

* -0

.06

0.39

**

-0.1

4 -0

.09

0.33

**

0.38

**

10. E

duca

tion

171

0.57

0.

47

-0.4

4**

-0.2

6**

0.55

**

-0.0

5 -0

.07

0.21

**

0.40

**

0.48

**

11. I

ndus

tria

l dev

elop

men

t 17

1 0.

74

0.57

-0

.51*

* -0

.29*

* 0.

49**

-0

.14

-0.1

6*

0.33

**

0.45

**

0.51

**

0.77

**

12. P

oliti

cal i

deol

ogy

171

0.38

0.

26

0.02

0.

09

-0.0

8 0.

11

0.07

0.

00

0.05

0.

10

0.07

0.

06

13. R

elig

ion

171

-0.6

2 0.

82

0.00

0.

22**

0.

20**

0.

04

0.01

0.

18*

-0.0

6 0.

35**

0.

21**

0.

18*

0.04

* p

< 0

.05.

**p

< 0

.01.


82

13

0.75

***

(0.0

7)

-0.6

3***

(0

.09)

0.86

**

(0.3

0)

-0.1

3 (0

.12)

-0.2

7 (0

.17)

0.64

7

171

12

0.76

***

(0.0

7)

-0.6

4***

(0

.09)

0.91

**

(0.3

0)

-0.3

3*

(0.1

6)

0.64

7

171

11

0.78

***

(0.0

7)

-0.6

6***

(0

.09)

0.89

**

(0.3

0)

-0.1

9 (0

.11)

0.64

4

171

10

0.86

***

(0.0

7)

-0.7

0***

(0

.09)

-0.1

7 (0

.13)

0.62

1

171

9

0.84

***

(0.0

7)

-0.7

3***

(0

.09)

-0.4

8 (0

.38)

0.62

1

171

8

0.78

***

(0.0

7)

-0.5

7***

(0

.09)

-0.7

3***

(0

.20)

0.64

6

171

7

0.81

***

(0.0

7)

-0.6

4***

(0

.10)

-0.4

5†

(0.2

6)

0.62

4

171

6

0.84

***

(0.0

7)

-0.6

6***

(0

.09)

-0.5

1†

(0.2

8)

0.62

4

171

5

0.83

***

(0.0

6)

-0.7

0***

(0

.08)

1.34

***

(0.3

3)

0.65

2

171

4

0.78

***

(0.0

7)

-0.6

7***

(0

.09)

-0.3

9*

(0.1

6)

0.62

9

171

3

0.80

***

(0.0

7)

-0.6

8***

(0

.09)

-0.2

5*

(0.1

1)

0.62

7

171

2

0.80

***

(0.0

7)

-0.6

9***

(0

.08)

0.98

***

(0.2

9)

0.64

1

171

Dep

ende

nt V

aria

ble:

Ln

FDI

1999

–200

3

1

0.83

***

(0.0

7)

-0.7

3***

(0

.09)

0.61

9

171

Tab

le 4

.2: R

esul

ts o

f the

gra

vity

mod

el fo

r FD

I lo

cati

on b

etw

een

1999

and

200

3

Inde

pend

ent

Var

iabl

es

Nat

iona

l in

com

es

Dis

tanc

e

His

tori

cal t

ies

Cul

tura

l di

stan

ce

Inst

itut

iona

l di

stan

ce

Com

mon

la

ngua

ge

Dem

ocra

cy

Educ

atio

n

Indu

stri

al

deve

lopm

ent

Pol

itic

al

ideo

logy

Rel

igio

n

Adj

uste

d R

2

N

Not

es: S

tand

ardi

zed

regr

essi

on c

oeff

icie

nts

repo

rted

; sta

ndar

d er

rors

are

in p

aren

thes

is.

Sign

ific

ance

leve

ls: †

p<0.

10. *

p<0.

05. *

*p<

0.01

. ***

p<0.

001.


83

24

0.79

***

(0.0

7)

-0.5

4***

(0

.10)

0.02

(0

.12)

-0.1

9 (0

.18)

1.19

***

(0.3

3)

0.06

(0

.31)

0.32

(0

.33)

-0.7

0**

-0.4

0 (0

.36)

-0.1

5 (0

.13)

0.66

8

171

23

0.75

***

(0.0

7)

-0.5

4***

(0

.10)

0.92

**

(0.2

9)

-0.0

5 (0

.12)

-0.1

8 (0

.18)

0.17

(0

.31)

0.25

(0

.34)

-0.7

5**

-0.4

2 (0

.36)

-0.1

5 (0

.13)

0.66

3

171

22

0.79

***

(0.0

7)

-0.5

4***

(0

.09)

0.01

(0

.12)

-0.1

5 (0

.17)

1.21

***

(0.3

3)

-0.5

2**

-0.3

7 (0

.36)

-0.1

3 (0

.12)

0.66

9

171

21

0.81

***

(0.0

7)

-0.5

9***

(0

.10)

-0.0

2 (0

.12)

-0.2

3 (0

.17)

1.27

***

(0.3

4)

-0.2

3 (0

.26)

-0.4

3 (0

.36)

-0.1

7 (0

.13)

0.65

8

171

20

0.82

***

(0.0

7)

-0.6

2***

(0

.09)

0.00

(0

.12)

-0.2

5 (0

.18)

1.28

***

(0.3

4)

-0.1

5 (0

.30)

-0.4

5 (0

.36)

-0.1

7 (0

.13)

0.65

7

171

19

0.75

***

(0.0

7)

-0.5

1***

(0

.09)

0.94

**

(0.2

9)

-0.0

6 (0

.12)

-0.1

4 (0

.17)

-0.5

9**

-0.3

8 (0

.36)

-0.1

1 (0

.12)

0.66

5

171

18

0.77

***

(0.0

7)

-0.5

5***

(0

.10)

0.97

**

(0.2

9)

-0.1

0 (0

.12)

-0.2

1 (0

.18)

-0.3

2 (0

.26)

-0.4

3 (0

.37)

-0.1

4 (0

.13)

0.65

2

171

17

0.78

***

(0.0

7)

-0.6

0***

(0

.09)

0.93

***

(0.3

0)

-0.0

8 (0

.12)

-0.2

6 (0

.18)

-0.0

8 (0

.31)

-0.4

8 (0

.37)

-0.1

7 (0

.13)

0.64

9

171

16

0.78

***

(0.0

7)

-0.6

5***

(0

.09)

-0.0

6 (0

.12)

-0.2

7 (0

.17)

1.19

***

(0.3

4)

0.65

4

171

15

0.79

***

(0.0

7)

-0.6

5***

(0

.09)

-0.2

9†

(0.1

6)

1.24

***

(0.3

3)

0.65

6

171

Dep

ende

nt V

aria

ble:

Ln

FDI

1999

–200

3

14

0.81

***

(0.0

7)

-0.6

8***

(0

.08)

-0.1

1 (0

.12)

1.23

***

(0.3

4)

0.65

1

171

Tab

le 4

.2: R

esul

ts o

f the

gra

vity

mod

el fo

r FD

I lo

cati

on b

etw

een

1999

and

200

3 (c

onti

nued

)

Inde

pend

ent

Var

iabl

es

Nat

iona

l in

com

es

Dis

tanc

e

His

tori

cal t

ies

Cul

tura

l di

stan

ce

Inst

itut

iona

l di

stan

ce

Com

mon

la

ngua

ge

Dem

ocra

cy

Educ

atio

n

Indu

stri

al

deve

lopm

ent

Pol

itic

al

ideo

logy

Rel

igio

n

Adj

uste

d R

2

N

Not

es: S

tand

ardi

zed

regr

essi

on c

oeff

icie

nts

repo

rted

; sta

ndar

d er

rors

are

in p

aren

thes

is.

Sign

ific

ance

leve

ls: †

p<0.

10. *

p<0.

05. *

*p<

0.01

. ***

p<0.

001.


84

In the final estimations (models 17–24), we work toward a full model. Because of the potential issues of multicollinearity among democracy, education, and industrial development (Dow and Karunaratna, 2006), we first estimate their effects separately (models 17–22). Somewhat surprisingly, the only coefficient that remains significant is that for differences in industrial development (models 19 and 22). The coefficients of historical ties (models 17–19) and common language (models 20–22) both remain strong and significant (p < 0.01 and p < 0.001, respectively). In the final set of models (23 and 24), we retain all variables, alternating only the collinear historical ties and common language variables. Consistent with our previous estimations, only the coefficients of historical ties, common language, and industrial development remain significant. The explanatory power of the models with historical ties (model 23) and common language (model 24) are comparable, with adjusted R2 of 0.663 and 0.668, respectively.

4.5 Discussion and conclusion

The study in this chapter attempts to reflect critically on the commonly held assumption that underlies the psychic distance construct, namely, that firms favour foreign markets that are similar to the home market and eschew the commitment of resources to markets that are dissimilar. We argue that decision makers may perceive some countries and markets as psychologically more close than others because of not only the degree of similarity between the home and the foreign country but also the extent to which that decision maker perceives the foreign market as familiar.

We explored the validity of our argument by contrasting the effect of a set of similarity-based psychic distance stimuli with that of historical ties, a country-level psychic distance stimulus that we associate with foreign market familiarity. The results suggest that historical ties, common language, and differences in industrial development provide a stronger and more robust explanation of the location of foreign direct investment than do cultural or institutional similarities or similarities in terms of the political system, education level, or religion.

Cultural and institutional distance By and large, we cannot confirm that differences in culture, as measured with Kogut and Singh’s (1988) measures, affect the location of FDI from the four source countries in our sample. Although our results suggest that cultural distance has merit as an explanatory variable when considered in isolation, this power mostly disappears when combined with other—better—explanatory variables, such as historical ties and common language. These results add to the work of those sceptical of the cultural distance concept or its supposed effects, such as Benito and Gripsrud (1992), Shenkar (2001), Harzing (2003), and Tihanyi, Griffith, and Russell (2005). We also confirm the


85

non-significant effect of cultural distance on internationalization decisions, even though Kogut and Singh’s (1988) index remains one of the most indiscriminately applied psychic distance surrogates.6

A similar conclusion emerges regarding the effect of institutional distance: It has some explanatory power when considered in isolation or in combination with historical ties and common language, yet the effect disappears when we combine institutional distance with additional variables, such as cultural distance and industrial development, with which it is moderately correlated. This finding is not to say that institutions do not matter in location decisions; as evidenced in other empirical studies (e.g., Bevan, Estrin, and Meyer, 2004; Jakobsen and De Soysa, 2006), institutional quality serves to increase the attractiveness of countries as destinations for foreign investment, even if the combination of institutional conditions that determine location attractiveness differs by region (Pajunen, 2008). However, our results do not support the notion that inherent institutional country differences have a negative effect on locational attractiveness, which casts doubt on institutional differences as a significant psychic distance stimulus.

Effects of democracy, education, religion, industrial development, and political ideology We estimate the effects of several additional country similarities using measures developed by Dow and Karunaratna (2006). Although the effect of differences in industrial development is significant, we find no consistent effects of differences in democracy, education, political ideology, or religion on the location of foreign investment. However, multicollinearity among industrial development, education, and democracy means these results are not necessarily unbiased.

For three reasons, we nonetheless recommend differences in industrial development as a key predictor variable. First, when we alternate the industrial development, education, and democracy variables in the extended models (models 17–22), only the coefficient for industrial development remains significant. Second, in our sample, differences in industrial development correlate most strongly with the location of foreign investment. In contrast with Dow and Karunaratna (2006), we therefore identify differences in industrial development, rather than differences in education, as the most significant psychic distance stimulus. Alternatively, the negative effect of differences in the degree of industrial development on the location of FDI may reflect the common notion that most MNE activity takes place within the “triad” of developed countries in the European Union, North America, and Asia (Rugman, 2000; Rugman and Verbeke, 2004). At the least, the results demonstrate

6 Kogut and Singh proposed the measure in a study on entry mode selection rather than on geographic location decisions. However, their measure thereafter has been applied in all sorts of studies related to foreign investment.


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that when it comes to the location of foreign investment, not all country differences equally affect location attractiveness. Third, the large differences in the effects of religion, education, and language support Dow and Karunaratna’s (2006) suggestion that the relative contribution of various psychic distance stimuli likely varies with the type of managerial decision or the type of entry mode. Effect of historical ties and common language Our estimates generally indicate that both historical ties and common language have significant effects on the location of FDI. The consistent effect of historical ties supports our hypothesis, yet these results require further comment because of the correlation between historical ties and common language (r� = 0.60). This finding is not surprising: In intensely colonized countries, native languages often got replaced with or complemented by the language of the colonizers. Two questions thus remain: Can the observed effect be attributed to either historical ties or common language, and does the significant effect of historical ties indicate a similarity effect or a familiarity effect?

To disentangle the effects of historical ties and common language, we removed countries with both a historical tie and a common language from our sample and re-estimate the effects of ties and language. Although the variation explained by historical ties remains consistently higher for all four periods, both ties and language become insignificant because of the reduced sample size. Strictly speaking, we therefore must conclude that the effects of historical ties and common language are inseparable on the basis of the current data set, and that both their effects are significant.

Thus, we turn to the question of whether the significant effect of historical ties should be interpreted as a similarity or a familiarity effect. A look at the correlation matrix indicates that though historical ties and common language are moderately correlated, neither correlates with any of the other similarity measures. This is not to claim that historical ties, for example, did not at least partially inform the parliamentary system of New Zealand or the legal system of South Africa. Rather, the correlation matrix illustrates that historically tied countries are not necessarily more similar in terms of the country characteristics most frequently associated with reduced psychic distance. In addition, though the effects of both historical ties and language are significant and robust, the effects of many similarity-based variables remain insignificant. These observations provide at least partial support for the argument that the effect of historical ties captures a construct distinctive from that of country similarities.


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The familiarity dimension of psychic distance The dominant argument in the field of international business regarding psychic distance and the location of foreign investment asserts that the higher the degree of (perceived) similarity between the home and the foreign market, the lower the psychic distance experienced (Johanson and Wiedersheim-Paul, 1975), whereas the lower the psychic distance, the less uncertain firms are toward a foreign market (Kogut and Singh, 1988), and the higher the propensity or likelihood that the firm will invest or expand in that country (Johanson and Vahlne, 1990). In this study, we developed the notion of familiarity and suggested that what determines psychological distance is not merely the perception of country differences but also the degree to which a decision maker perceives a foreign market as familiar. Our empirical finding that historical ties, common language, and industrial development have a strong effect on the location of foreign investment, whereas the effect of other measures of country similarities is not significant, adds support to our argument that current conceptualizations of psychic distance overlook an important dimension.

The familiarity construct offers interesting implications for the psychic distance concept and internationalization process theory. Country differences may inhibit the flow of information between foreign markets and the firm (Brewer, 2007; Johanson and Vahlne, 1975), yet cognition research demonstrates that both knowledge and beliefs depend on a much wider range of information sources at the individual, organizational, and national levels (Walsh, 1995). As a result, a person may claim familiarity with countries that he or she perceives as very different from the home country. Future research should examine the implications of such off-diagonal relations on the perception of psychic distance. In addition, holding or forming beliefs about foreign markets requires no actual experience, which implies that prior to entry, foreign markets may be perceived already as familiar (e.g. Pedersen and Petersen, 2004), with high confidence levels about the foreign context, even in the absence of actual local knowledge. Therefore, further research should also examine whether the perception of familiarity permits firms to demonstrate high levels of local engagement, even at entry.

Our study also comes with two important caveats. First, though the use of country-level data enabled us to study the effect of several alleged country-level antecedents of psychic distance on aggregate firm behaviour, it does not allow for the measurement of psychic distance itself, which requires detailed firm- or individual-level data. Our level of analysis also implies that we cannot comment on the effect of historical ties on the actual internationalization sequence of firms or the commitment of resources to foreign markets over time. Despite these significant shortcomings, our results suggest that for the location of foreign investment, not all country similarities have equal weight as psychic distance stimuli. A comparison with Dow and


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Karunaratna (2006), who use trade intensity as their dependent variable, reveals that our results support their notion that the relative contribution of psychic distance stimuli may also differ, depending on the entry mode decision. For example, whereas a common language is not conducive to trade, language may positively affect location decisions when such decisions involve local investments.7 Our results therefore caution against the indiscriminate use of country differences as a surrogate for psychic distance.

Second, the historical ties variable we develop arguably provides a rather crude indicator of the perception of familiarity, and it may be compromised by its correlation with common language. In addition, as we have emphasized, many other factors likely influence the extent of perceptions of familiarity with a foreign market. We focus on historical ties mainly because they frequently have been recognized as potential psychic distance stimuli (e.g. Brewer, 2007; Dow and Karunaratna, 2006), though usually with the assumption that they engender country similarities—an assumption that, with the exception of common language, our data do not support.

7 In contrast with our findings, in Dow and Karunaratna (2006) the coefficient of the language variable—which correlates strongly with our common language dummy (r = 0.84)—is not consistently significant.

Chapter 5

Internationalization and MNE responses to unlearning—The case of a German publishing house

5.1 Introduction

In a sample of 38 Canadian firms which had undergone some form of post-entry mode change in their foreign operations, Calof (1993) noted that 39% of the mode change decisions were primarily based on gut feel and subjective beliefs about the foreign market environment. Another 28% of the mode change decisions were based on a combination of both gut feel and rational decision-making. From the perspective of internationalization process theory, Calof’s observation is interesting for at least two reasons. First, his observation challenges the assumption that decisions on the degree of foreign involvement are primarily based on the actual knowledge firms have of foreign markets (Johanson and Vahlne, 1977; Johanson and Wiedersheim-Paul, 1975). Second, his observation draws attention to the question how MNEs respond when the subjective beliefs and assumptions on which such internationalization decisions are based, are disconfirmed.

The aim of this chapter is to draw attention to the implications of these issues for internationalization process theory, and for its predictions regarding the expansion within foreign markets in particular. The argument developed here is that several key assumptions of internationalization process theory regarding the relation between knowledge and uncertainty should be reconsidered, and that this is required in order for internationalization process theory to remain a viable behavioural alternative to efficiency-based theories. In particular, in this chapter it is argued that by focusing too narrowly on the accumulation of actual knowledge, internationalization process theory has overlooked the uncertainty-reducing effects of both knowledge and prior beliefs and assumptions. This, it is argued, unnecessarily limits the explanatory power


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of internationalization process theory regarding entry mode selection and location decisions.

In addition, by emphasizing the importance of experiential knowledge in understanding foreign markets and contexts, internationalization process theory overlooks the effects of unlearning on internationalization processes. The implications of such unlearning processes—the organizational responses they elicit—have received surprisingly little attention, yet a small but increasing number of studies indicate its importance. In this chapter, it is therefore argued that internationalization is better conceptualized as a process involving both the accumulation of internationalization knowledge and local market knowledge (Eriksson, Johanson, Majkgård, and Sharma, 1997), and the unlearning of the unsubstantiated beliefs and assumptions which are initially held true regarding the nature of foreign contexts, and regarding the international industry requirements.

In this chapter, I illustrate these arguments and take their development further by presenting an embedded case study on the internationalization process of a major German publishing house into Central Eastern Europe and Russia. The German publisher’s inter-nationalization process is characterized by high-commitment entry modes and by fundamentally different responses to the disconfirmation of key assumptions in the Hungarian and the Russian market, suggesting interdependence between knowledge type and MNE response. The presentation of the case is followed by a discussion of the case findings, and by a discussion of the potential implications for internationalization process theory. This is followed by several suggestions for future research.

5.2 Knowledge, uncertainty, and familiarity perceptions

Among the predominantly economics-based theories of international firm behaviour (see Chapter 1), the internationalization process model is an exception in that it attempts to offer a behavioural explanation of both foreign market selection and the degree of foreign market involvement. Internationalization process theory (IPT) posits that a lack of knowledge is one of the key deterrents to the commitment of resources to foreign markets (Johanson and Wiedersheim-Paul, 1975; Johanson and Vahnle, 1977; 1990): a lack of foreign market knowledge is argued to limit a firm’s ability to accurately spot problems and opportunities, while a lack of international experience hampers a firm’s ability to successfully organize its activities abroad (Eriksson, Johanson, Majkgård, and Sharma, 1997). The uncertainty resulting from a lack of knowledge is argued to defer the commitment of resources, especially in the initial phases of a firm’s internationalization process. As a result, the international

Chapter 5: MNE Responses to Unlearning

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neophyte is expected to initially favour less-committed modes of operation1, which limit the firm’s exposure to the unfamiliar foreign context.

The distinction is made between knowledge which is objective and therefore relatively transferable, and knowledge which is much more tacit and therefore hard to acquire other than through experience. It is argued that contextual knowledge of foreign markets is particularly tacit, and therefore not easily transferred between firms or individuals, or from one country to another. The tacitness of contextual knowledge is illustrated by the study of Eriksson et al. (2000), whose findings suggest that experience in diverse foreign markets positively affects internationalization knowledge, but not (directly) local business and institutional knowledge. To some extent, it is therefore assumed that internationalization knowledge is transferable, which eases subsequent foreign entries, while contextual business and institutional knowledge is considered too context specific to be transferred.

The argument developed here is that some of the most pressing empirical and conceptual concerns with internationalization process theory stem from the fact that while cognitive learning is implicit in internationalization process theory, its implications are underdeveloped. First, by assuming that entry-mode and mode change decisions are primarily based on actual knowledge, internationalization process theory overlooks that in the absence of actual knowledge of a foreign market environment, key decision makers may still hold subjective beliefs and assumptions about the nature of a foreign host context, on which commitment decisions can be based. In other words, internationalization process theory overlooks that the knowledge structure of decision makers consists of both the actual knowledge decision makers have as well as the subjective beliefs and assumptions which decision makers hold to be true (Walsh, 1995; Markóczy, 1997). Such subjective beliefs can be expected to reduce the uncertainty experienced towards a foreign market environment, and affect decision maker’s perception of foreign market familiarity even in the absence of local knowledge. As discussed earlier (see Chapter 2), what this suggests is that a firm’s degree of market commitment may be proportional to the perception of familiarity with a foreign market environment, rather than merely to the stock of knowledge. In other words, firms which perceive new foreign markets as rela-tively familiar can be expected to experience less uncertainty towards these markets, and to demonstrate relatively high levels of local involvement even upon entry.

Second, the characterization of internationalization as a unidirectional ‘learning through experience process’ may be overly simplistic. As Hedberg (1981) explains, from a cognitive perspective “[u]nderstanding involves both learning new knowledge and discarding obsolete and misleading knowledge” (Hedberg, 1981: 3). When

1 The term ‘mode of operation’ is derived from the work of early internationalization process theorists (Johanson and Wiedersheim-Paul, 1975; Johanson and Vahlne, 1977) and here refers to the organizational form of a firm’s involvement in a foreign market. The term ‘entry mode’ is subsequently used to denote a firm’s selected mode of operation upon entry.


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operating abroad, the initial beliefs and assumptions which affected firms’ initial entry decisions, are exposed to the foreign context. While some initial beliefs and assumptions may prove to be correct, it is likely that most of the initial beliefs are eventually disconfirmed and discarded as incorrect. A study by Pedersen and Petersen (2004) on managing directors’ self-reported understanding of foreign markets illustrates this point. Pedersen and Petersen (2004) find that for up to eight years after having been assigned to a foreign position, expatriates’ self-reported degree of knowledge of the focal host environment tends to decline rather than increase. This illustrates that, from a cognitive perspective, contextual learning may encompass the unlearning of prior beliefs as much as the mere accumulation of experiential knowledge. As a result, MNEs may unexpectedly experience post-entry knowledge deficiencies.

5.3 The case of a German publishing house

This chapter applies an embedded case study on the internationalization process of German publishing house “Altona”—a pseudonym—to illustrate these arguments, and to take the development of their implications further. The descriptive and illustrative power of case studies has been recognized as a valuable tool in inductive theory building (Siggelkow, 2007); especially since case studies have the potential to “provide freshness in perspective to an already researched topic” (Eisenhardt, 1989: 548). Striking about the Altona case is the counter-intuitive selection and persistence of relatively high-commitment entry modes in markets of which Altona had very little prior knowledge. The focus here is therefore on the motivation for the selected entry modes, and on the alternative organizational responses Altona employed to the disconfirmation of several key assumptions.

Data for the case study was obtained from a variety of primary and secondary sources. Interview data was obtained through both personal and telephone interviews, which were semi-structured, and which ranged from 50 minutes to over two hours. Interview topics covered entry mode selection, subsidiary development, the perceived degree of familiarity at the time of entry, and the perception of foreign markets, among others. Most interviews were digitally audio-recorded with permission of the respondents, which greatly facilitated the reproduction and writing down of illustrative anecdotes. The selected respondents, which included the director of Central Eastern Europe, local CEOs and local managing directors, had all been personally involved in the setting up and/or the subsequent development of a local subsidiary.2 Data obtained from secondary sources included newspaper articles

2 This includes the Hungarian subsidiary, which was set up as early as 1988.


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collected electronically through the LexisNexis online database and copies of newspaper cut-outs collected at the (former) Hamburgisches Weltwirtschaftsarchiv. This was complemented with corporate publications, such as press-releases (available online) and annual reports. A brief historical overview With over 10,000 employees, a portfolio of over 50 magazines in its domestic market alone, and advertising and circulation revenues of well over � ! 2 bn, Altona is one of Europe’s biggest newspaper and magazine publishing houses. Altona, founded right after World War II, publishes Germany’s biggest selling national newspaper—a daily tabloid known for its populist reporting—as well as a more upscale national daily. In addition, Altona also publishes several regional titles. In all, Altona has a market share of around 20% in the total German newspaper market. Although a newspaper company at heart, Altona has diversified into magazines, most notably the segments for car and computer magazines as well as TV guides, women’s magazines, and several specialist segments. Currently the newspaper segment accounts for around 60% of Altona’s total revenue, whereas the magazines segment accounts for roughly 30%.

With the gradual appointment of a new management board in the early 2000’s, the strategic focus of Altona shifted towards its international activities. Altona operates abroad through eight wholly owned subsidiaries, a joint venture, and through the licensing of many of its magazine titles. For example, its leading car magazine is licensed to 29 countries, selling over 5 million copies each month. In all, Altona titles are published in well over 30 countries worldwide.

Altona has maintained offices abroad since 1988, but while it was among the first Western publishers to enter the former Eastern Bloc, Altona has lagged behind its main competitors in terms of the development of its international activities. Compared with other leading publishing houses, Altona has a strong regional focus on Central Eastern Europe. Apart from subsidiaries in France, Spain, and Switzerland, Altona operates through wholly owned subsidiaries in Hungary, Poland, the Czech Republic, and Russia, while maintaining a strategic stake in a Romanian joint venture with Swiss publishing group Edipresse (see Box 1). Within Central Eastern Europe, Altona focuses predominantly on the Hungarian market, in which it is the leading publishing house; the Polish market, where it publishes the country’s leading daily newspaper; and the Russian market, which Altona entered in 2003. Due to the relative importance of these markets and the restricted access to Altona’s other subsidiaries, it is these three entries which are of key interest in the present study.

Figure 5.1 charts the internationalization pattern of Altona in Central Eastern Europe in terms of timing, entry mode and mode of operation. Except for the Hungarian entry in 1988, for which a partnership was formed with a local partner, Altona entered the markets in Central Eastern Europe through wholly owned


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subsidiaries. Not taken into account in Figure 2 are the titles Altona licenses to local publishers. Examples are the licensing of Altona’s leading car magazine Autobahn [another antonym] in Serbia, Estonia, and Latvia, or the licensed editions of it’s leading computer magazine for the Lithuanian and Bulgarian markets. Due to the low degree of actual involvement of Altona—especially since the licensing of titles is initiated by local licensees—and given that the licensing of magazine titles allows little to no room for experiential learning3, Altona’s licensing of domestic titles to foreign publishers hardly classifies as foreign market entries. Licensing is therefore not considered here.4

‘88 ‘90 ‘92 ‘94 ‘96 ‘98 ‘00 ‘02 ‘04 ‘06 ‘08

Hungary

Poland

Czech Republic

Romania

Russia ?

Mode of operation Joint venture

Wholly owned subsidiary

? Uncertain

Figure 5.1: The internationalization pattern of Altona into Central Eastern Europe

3 The licensing of individual titles out of Altona’s vast portfolio offers little opportunity for experiential learning, as the need for intensive monitoring of its licensees is low. The possibilities for reputation damage are limited, as are the possibilities for opportunism. This in contrast to manufacturing firms, which are often at the focus of studies that do consider licensing as an entry mode alternative (e.g. Contractor, 1984, Shane, 1994). The licensing of sensitive technology offers more scope for opportunism, and monitoring is more of an issue. It also contrasts with single-product publishing companies such as Forbes, which more intensely monitor the editorial policy of their foreign licensees due to the higher risks of reputation damage. 4 It should be noted that the licensing of magazines did not precede Altona’s entries into the Central Eastern European markets.


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Box 1: The Romanian entry

Altona entered the Romanian market in 1999 through the acquisition of a local magazine publisher. Contrary to competitor Gruner+Jahr, Altona refrained from launching a local newspaper. Instead, Altona focused on the publishing of new magazines, among which a women’s title, a youth monthly, and two entertainment magazines. In 2002, Altona reduced its involvement in the Romanian market by accomodating its activities in a joint venture with Swiss-owned Edipresse, in which it since holds a 40% stake. The main reason identified for the withdrawal from the Romanian market was that Altona proved to be relatively unsuccessful in launching magazines for the Romanian market (circulation numbers for its local titles appear to have ranged from 30,000 to 70,000). The reasons given for maintaining a minority stake rather than fully withdrawing from the Romanian market point in the direction of the learning opportunity a minority stake provides in contrast with a full withdrawal. As the president for Central Eastern Europe and Southern Europe explained:

“[…] we could have also sold this business to a partner, but we said: no it’s just on the edge to be an interesting country. Twenty-something million inhabitants, so we finally decided it would have been a pity to totally leave the country. Because if you once leave by selling, you close the doors for later activities […] we are very happy now because now the entire company is leading in Romania, and it’s profitable, and we’re still there. So if one day we would like to be more active, we still have a position there in this country.”


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5.4 Findings

In the following sections I first present Altona’s motivation for entering the unknown Hungarian, Polish, and Russian markets through high-commitment entry modes. Several sources of foreign market familiarity are identified, such as prejudices and gross generalizations, which appear to have reduced some of the uncertainty experienced upon entry. I then draw attention to the alternative responses of Altona to the disconfirmation of several key assumptions in Hungary and Russia. Whereas in Hungary, Altona’s wholly owned subsidiary persisted despite incorrect assumptions about the required degree of local responsiveness, in Russia the disconfirmation of key assumptions resulted in the consideration of a less committed mode of operation. 5.4.1 Entry mode selection and familiarity perceptions Internationalization process theory predicts that a firm’s involvement in foreign markets follows an incremental process of knowledge accumulation and subsequent increases in foreign market commitment. Since a thorough understanding of foreign markets can only be gained through actual experience in these markets, initial market commitments are predicted to be modest at best. Yet contrary to what would be expected on the basis of internationalization process theory, Altona’s entries into the Central Eastern European markets are mostly characterized by high initial market commitments in the form of wholly owned subsidiaries (see figure 5.1). Although actual knowledge of these foreign markets was low, most markets were generally perceived as relatively familiar upon entry, which appears to have reduced some of the uncertainty associated with these markets. There are two key reasons for the relatively low initial uncertainty experienced with respect to the Hungarian, Polish, and Russian media markets. First of all, Altona’s entry into Hungary was based on strong beliefs about the extent to which prior experiences in the German home market could be successfully translated to the Hungarian media market. Secondly, positive experiences in previously entered foreign markets started to serve as a basis for generalizations about the nature of other foreign markets; the Russian market in particular. The Hungarian Entry Altona’s entry into the Hungarian market in 1987 is consistently described as opportunity-driven rather than strategy-driven. Following the early transitional changes in Hungary, which opened up the local media market to foreign investors, the board of Altona was brought into contact with a local entrepreneur through the personal network of one of its board members. Together with the local Hungarian, who would become jointly responsible for the development of the Hungarian subsidiary, Altona set up a joint venture in Budapest. Altona quickly gained a firm


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foothold in the Hungarian media industry, in particular through the acquisition of close to half a dozen regional newspapers. In all, the rationale behind the choice of location and the motivation to expand internationally was opportunity-driven. Preparations for the Hungarian entry were limited, and no extensive market research was performed. As one respondent sums up: “[i]n Hungary there was simply the opportunity, and the ex-chairman of Altona said “Oh, let’s try it; sounds interesting, the guy’s nice”.”

Altona entered the Hungarian market through a joint venture rather than through a wholly owned subsidiary due to Hungary’s restrictions on foreign ownership at the time. As the president for Central Eastern and Southern Europe explained:

“Hungary was, just for formal reasons it was a joint venture in the very beginning, because we could not own it entirely. Because, remember it was before officially the wall came down. […] it was just a formal reason why we didn’t do this a hundred percent.”

The formation of a joint venture with a local partner did however conveniently compensate for knowledge-deficiencies at both partners. In pre-transition Hungary,

Box 2: The Hungarian subsidiary

Altona’s entry into the Hungarian newspaper market was effectuated when Altona gained control over half-a-dozen regional newspapers. The deal was completed amidst a struggle between the Socialist Party (an offshoot of the former Communist Party), Western media conglomerates, and the opposition parties, for control over the local media. Altona’s entry became highly controversial, as the editorial staff of the regional newspapers officially resigned from their posts as employees of the Socialist Party, only to sign as editors for Altona the next day. Although Altona officially maintained that the regional titles were simply newly created dailies, the deal was dubbed as a case of ‘spontaneous privatization’ by Socialist Party officials. Altona early on attempted to develop several magazines in the hobby and TV segments, distributed initially through local post offices. Distributional problems were circumvented in part by setting up an independent distribution system, while a publishing facility was created in cooperation with the Hungarian state. With Hungary moving to a free-market economy, Altona gained full control of its Hungarian operations, except for a small equity stake which remained in the hands of the local CEO. Currently Altona is the leading publisher in Hungary, with 10 newspapers—both regional and nation-wide dailies—and well over 20 magazines. The magazines include licensed foreign business titles, as well as typical Altona titles in the car and entertainment segments, and many local titles.


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knowledge of modern publishing techniques was low, and there was no tradition of independent journalism. As one German involved in the early development of the Hungarian subsidiary describes: “[Altona’s local partner and future local managing director] thought it would be good to have the big Altona company in the bag and to get all this knowledge transfer and so on and so on.” On the other hand, at the time Altona was primarily focused on its domestic market, and involving a local partner was a convenient way to compensate for a lack of internationalization experience. In addition, neither the people at Altona Headquarters nor the Germans detached locally had any actual knowledge of the Hungarian market, as the following citation illustrates in retrospect: “I wouldn’t say that Altona knew about the Eastern European markets. It was an opportunity; and obviously it was not too expensive.” And, as a German respondent involved in the early development of the Hungarian subsidiary admitted: “I only knew about Hungary what I had seen on television”. The Polish Entry Compared with Altona’s entry into Hungary, the Polish entry in 1994 was prepared in a more systematic manner. Following good experiences in Hungary with a strong and relatively autonomously operating local managing director, Altona duplicated the Hungarian subsidiary model in Poland. However, there was a different rationale

Box 3: The Polish subsidiary

By the time Altona entered the Polish market in 1994, various small and large European publishing houses had already acquired most of the traditional domestic titles in the newspaper and magazines industry. In addition, since the costs of launching a new magazine were a mere fifth of launching a new magazine in a Western European market, numerous new titles were launched. Altona’s first Polish launch (initial circulation 1.1 million copies) was a weekly women’s magazine based on a successful domestic title. Although Altona considered the women’s magazine a test case, it quickly became the leading magazine in its segment. This was followed in 1998 by the launch of a monthly women’s magazine. Altona subsequently moved into the segment for business magazines with the launch of licensed Polish editions of Newsweek (launched in 2001) and Forbes (2004, initially named ‘Profit’). A move into newspapers was delayed until 2003, when Altona for the first time in years launched a daily tabloid modelled after its domestic tabloid in a foreign market. It became an instant success, replacing established newspapers such as Gazeta Wyborcza and Rzeczpospolita as Poland’s best-selling daily newspaper with a daily circulation of over 500,000. In 2006, Altona launched a similarly successful upmarket daily. In all, Altona currently claims a market share of over 40% of the Polish newspaper market.


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behind Altona’s entry into the Polish market. Whereas the Hungarian entry was largely the result of a one-off opportunity, the Polish expansion was described as motivated by the personal need for achievement of one of the board members. As one interviewee explained: “[t]he board member who was in charge of foreign countries changed, and then [this board member] became board member for magazines and international businesses, and he wanted his success story.” In addition, since most of the Western European markets were already saturated, the selection of the Polish market was largely described as a negative choice. The interviewee continues:

“And then [the new board member], as I said, he became board member and he said ‘Ok, where are the markets? Ok, we failed in France and so on. Eastern Europe, growing markets, and so on. What’s the biggest market? Oh, it’s Poland. Let’s go to Poland’.”

In terms of product strategy, Altona applied a similar strategy to Hungary in focusing on strong distribution targets rather than advertising, a strategy it also largely pursued in the German home market. In terms of products however, the focus was predominantly on women’s magazines rather than newspapers. While women’s magazines are generally considered a low-risk market segment, Altona’s initial product strategy in Poland also resulted from the fact that the board member

Box 4: The Russian subsidiary

Altona intended to enter the Russian market conservatively by launching two well-established, licensed publications: business monthly Forbes, and news weekly Newsweek. While name recognition was initially seen as an advantage, Altona experienced one of the challenges high-profile foreign brands may face upon entry in Russia: the brand name Forbes had already been claimed and registered as early as 1996 by one of Russia’s most well-known brand racketeers. Altona got an early taste of the often surreal Russian business climate when the owner of the brand agreed to cede its rights to the brand name only if, in exchange, the Forbes family returned to the Russian state nine Fabergé eggs it was about to auction (estimated worth: $90m). The case was eventually settled. In 2004 Altona launched its first local editions of both Forbes (circulation 40,000), which in its second issue included an extensive list of Russia’s wealthiest people, and Newsweek (circulation of 50,000). In July 2004, the local Forbes editor-in-chief was shot dead outside his office—an assassination which remains unsolved, but which has been linked to his work as an investigative journalist. In 2005, a licensed local edition of British design magazine Wallpaper* was launched (now discontinued), with Altona’s domestic computer title and a licensed lifestyle magazine following in 2006.


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responsible for international business was also responsible for magazines, rather than newspapers.5 The Russian entry Sixteen years after entering its first market in Central Eastern Europe, in 2003 Altona entered the Russian market. Although a newspaper publisher at heart, Altona initially decided to focus on magazines rather than daily newspapers. One of the last big—predominantly German—European publishing houses to enter Russia, it faced stiff competition in the magazine segments which were regarded as the archetypical Altona segments, such as the markets for car and women’s magazines. As a result, Altona initially focused on publishing licensed international independent news and business magazines.

The entry strategy followed in Russia was based largely on the positive experience with the Hungarian model. A wholly owned subsidiary was formed which would operate under the relatively autonomous auspices of a local Russian manager. It is striking that upon entry, the Russian market was perceived as relatively familiar. One factor which fuelled this perception was Altona’s previous experience in Poland. Interviewees not based in Russia frequently made comparisons between Poland and Russia, as if market conditions were relatively comparable. Another factor was the personal experience of the manager responsible for Altona’s expansion in Central Eastern Europe: “Since I was responsible already for Poland and Russia for [a competitor], I felt that I was pretty familiar with the mentalities of Eastern Europe.”

Yet, although perceived familiarity with the Russian market was sufficiently high to warrant entry through a wholly owned subsidiary, actual knowledge of the Russian market was low. When asked to comment in retrospect on Altona’s actual understanding of the Russian market upon entry, the local manager replied:

“I have seen so many German investors and helped them to run their businesses; I would say that Altona had a typical sort of mind-set like all of them. And you learn only in reality. […] I cannot judge Altona’s mindset. They understood that [Russia]’s an emerging market, we have to be here, they understood we have to move. But I think they underestimated the distributional situation in Russia, which is a natural bottleneck in this country […] I think that [the president of Central Eastern and Southern Europe] for example understands in Berlin what’s going on, he used to be a general manager in Poland, […] but Russia is not Poland, that’s another topic. More or less, it’s a learning experience.”

5 Altona only launched its first newspaper in Poland in 2003. This daily tabloid soon established itself as the leading daily newspaper in Poland, which enticed Altona to launch another newspaper in 2006, analogous to the compact version of its more upscale daily newspaper in the German home market.


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In fact, the lack of actual knowledge of local market conditions in Russia was such that the Russian managing director felt compelled to initiate an internal PR campaign to raise awareness of Russia at Headquarters. As she explains with respect to her initiative: “Beforehand, it was only two three people who knew “Ok, this is Russia”.”

Generalizations about Russia on the basis of Altona’s positive experience in Poland reduced some of the uncertainty associated with entering the Russian market. Yet, there were limits to the extent to which experiences in the Polish market could be reasonably generalized to the Russian market. As a result (as discussed later on) there are several examples of underestimations of local market conditions in Russia due to assumptions based on the Polish market. In all, the main reason why Altona entered (or soon established) the markets in Hungary, Poland, and Russia through relatively committed modes of foreign entry appeared to be due to the perceived familiarity with the local markets. Whereas the Hungarian entry was initially based on assumptions of similarity with the German home market, the Polish and Russian entries were largely based on generalizations of the market environments Altona had encountered earlier. 5.4.2 Sources of familiarity Given the lack of any actual understanding of the Central Eastern European markets, Altona’s decision to opt for relatively committed entry modes is striking. However, as indicated above, what appears to have reduced at least part of the uncertainty associated with entering these unknown markets, were relatively strong preconceptions, generalizations, and outright prejudices about the nature of the markets and the broader societal contexts in Hungary, Poland, and Russia. Such subjective beliefs appear to have fuelled the perception of familiarity, thereby partially compensating for a lack of experiential knowledge.

The factors which appear to have affected the perception of familiarity with these foreign markets can broadly be grouped at three different levels. While some factors particularly affected the perception of foreign markets at the individual level, such as earlier personal experience with a foreign market, other factors, such as prior entry in seemingly similar markets, appeared to affect Altona’s perception of Central Eastern Europe at the organizational level. In addition, several factors emerged at the national level, such as media coverage, which appeared to have had an effect on how foreign countries and markets were perceived.


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Individual level At the individual level, several factors appear to have had a bearing on the mental representations of the countries in the former Eastern Bloc by the German managers. The following excerpt from one of the interviews illustrates how unfounded prejudices gave rise to particular mental representations of the countries in Central Eastern Europe and their nationals:

“I’m a Westerner, a Western German. So I didn’t have a clue, well not automatically, but I almost had no clue how life really was in the Eastern Bloc. I was just once or twice in East Berlin, but that was really my sole experience, live experience of the Eastern Bloc. For me, Poland, that was really the first time that I entered a country of the former Eastern Bloc. And I had many prejudices. So I imagined how the life was, and one of my prejudice was that it’s a little bit like the Third World. And when I came there I was surprised how close people were. I mean […] the standard of life. I mean it was much less than in the West […] but I was surprised. I mean, it sounds a little bit stupid but I was surprised how normal the life was, and how normal people were. I thought they were a little bit like aliens or something […] But my main surprise was they were no aliens and they were very close, and they were very keen to develop and to catch up with the development.”

In addition, factors such as a personal fascination with the region, as well as first-hand experience through tourist visits or temporary assignments, both seemed to shape and change the personal perceptions of these countries. As the president for Central Eastern Europe explains: “Since I was responsible already for Poland and Russia for Gruner+Jahr, I felt that I was pretty familiar with the mentalities of Eastern Europe.” In turn, the personal interests of the German manager of the Russian subsidiary largely shaped her perception of Russia. But while she initially presumed to be quite familiar with the political side of post-Soviet Russia, after twelve years of actual experience in Russia she had to conclude that she was still in the dark about the actual influence of Russian politics on business in Russia.

“I’m West-German, so no Russian connotation or Soviet Union background […] Politically [when I started I felt I knew the country] pretty well. I was always interested in Soviet Union literature, history, and understanding what’s going on. It’s a typical syndrome of Cold War curiosity. [But when I arrived in Russia,] I lost ten kilos in the first year. Because there was no food and I didn’t understand the system of ‘talonsky’, which is what you needed to buy products. I didn’t figure out the system that I was not officially registered, so I could only buy products and food on the free market […] Today, after 12 years I have to say yes,


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I totally understand more or less the structure of networking […] but the political sort-of Kremlin side still is a black box.”

Organizational level In a similar manner, there are several factors at the organizational level which explain how managers at Altona in general perceived the Central Eastern European markets. These are Altona’s dominant position in the German home market, subsequent experiences in local markets which formed the basis for generalizations about other markets in Central Eastern Europe, and, to a certain extent, Altona’s historically adverse stance against the totalitarian regimes of the former Eastern Bloc. First of all, Altona’s experience with the German home market, in which it occupies a dominant position, affected the perception of the Hungarian consumer market as well as the perceived ease with which potential obstacles could be overcome. Reflecting on Altona’s entry into Hungary in the late 1980s, a manager recalls:

“Altona underestimated the buying power. Totally. And the need to think in various product categories. Because Altona, […] with 80% of their products they work in monopolies. […] If the organization mainly works in monopolies, you don’t have this variety of consumer groups in your mind when it comes to product decisions and development decisions, and that was a problem for Altona at that time, and they had to learn it over the years. And if you look at other companies, to a certain extent they manage it better to shape special products for special markets, because they’ve been used to it, also in their home markets.”

Similarly, as described earlier, Altona’s experiences in the Hungarian and Polish market served as a basis for generalizations on the nature of the Russian market. Relatively naïve assumptions, such as on the extent to which an acquisition strategy could be pursued in Russia, or on the degree of independence with which the Russian media industry operates from political and business interests, seem to have at least reduced part of the uncertainty experienced upon entry of the Russian market.

The historically adverse stance against totalitarianism also affected both Altena’s perception of Central Eastern Europe and, in particular, how the firm was initially perceived in Hungary. The founder of Altona was fervently opposed to the totalitarian regimes in the Eastern Bloc in general, and to the division of East and West Germany in particular. This was reflected, among others, in Altona’s corporate principles, and in newspaper reports on the German Democratic Republic, which was consistently sarcastically referred to between quotation marks (“DDR”). One may therefore be tempted to consider Altona’s entry into the newly liberalized Hungarian newspaper market from a messianic perspective. However, Altona’s Hungarian entry was first and foremost an opportunistic rather than ideological decision. Yet, the public stance


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against totalitarianism did reflect positively on how Altona was initially received in Hungary. A German manager recalls:

“[Altona’s publicly negative stance against totalitarianism in Central Eastern Europe] affected Altona in the beginning; or Altona, the perception of Altona. Because that’s what we heard often in the very early years, that people think and thought: ‘OK, Altona must be very good company, and they’re a friend of ours’ because of this special political wish. But this is no longer the case, as the current political problems in these countries […] affect these people much more.”

National level In addition to factors at the personal and organizational level, factors at the national level also appear to have influenced the perception of familiarity with the markets in Central Eastern Europe. Three factors which emerged are media coverage, national stereotypes, and historical ties.

Through media coverage, selected accounts of events unfolding abroad reach a wide domestic audience. As a source of information, media coverage therefore has a direct bearing on the perception of familiarity with these countries. Yet the selective nature of media coverage has also been found to foster particular stereotypical beliefs about foreign countries and their nationals (Eagly and Kite, 1987). Therefore, media coverage may also serve as the basis for further generalizations and subjective assumptions about the nature of a foreign country. Either way, media coverage can positively contribute to the perception of familiarity, especially when other information sources are lacking. As a manager involved in the early development of the Hungarian subsidiary indicated, when asked to reflect on his actual knowledge of Hungary prior to being transferred to Budapest: “I only knew about Hungary what I had seen on television”.

National stereotypes are the second country-level factor which affected the perception of Central Eastern Europe. In general, such incorrect preconceptions were quickly disproved. Reflecting on his initial perception of Poland, one manager admits: “The Poles are very ambitious. They’re working hard. If you ask, normally the German prejudice of Poles is that they’re not working and that they’re lazy, and they’re just stealing. But they’re very hard-working.” Yet a particularly dramatic example of a case where the exception proves the rule unfolded in Russia. The managing director for Central Eastern Europe described the case where the stereotypical image of Russia as a country where disagreements are settled through the bottle or the bullet, was tragically confirmed rather than disproved:


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“We lost one editor-in-chief who was shot dead, so this was… Never, even not our Russian… At that time the managing director was a Russian lady, for years in the business, and even she; she was more shocked that the guy was shot dead than we. If you read German newspapers, and that’s probably the same with Dutch newspapers, we live with the imagination, with the prejudices that people are shot dead in Russia, so I mean, that it could happen. That’s not very likely, but you live with the likelihood that it could happen. But our Russian lady, she was so surprised, she was more surprised than we were; because she, as a Russian living there, she could not imagine that this still happens; that people are shot dead.”

A third country level factor which appears to have had its bearing on how the Central Eastern European countries were perceived, are historical ties, such as—but not merely—the German occupation of much of the region during the Second World War. Due to this historical event, most German managers seemingly expected to be treated with a certain degree of resentment. Yet these same managers all reported that to their surprise, they had never been unnecessarily confronted with the Second World War, and none had ever been treated badly on the basis of their nationality. In fact, similar to how Altona’s perspective on the totalitarian regimes of the former Eastern Bloc reflected positively on how Altona was initially perceived in Hungary, there seemed to be a certain degree of reciprocity with respect to the effect of historical ties. The Russian managing director:

“German-Russian cultural historical ties are extremely strong. […] We have lots of historical ties which Russians learned at school, [about the] history between Germany and Russia […] Russians never had any sort of second thoughts about [me] being German, and never ask questions about the war, never treated me like shit, which is amazing because what we’ve done here was a disaster. And there were no, never, connotations that “Oh my god you’re German, we don’t want to work with you”. Opposite. They strongly believe in the sort-of ‘made in Germany’ quality stuff, they strongly believe that we are organized, disciplined, and that we are sometimes a little bit stubborn.”

As such, historical ties may have a reciprocal effect by enabling a form of reminding and remembering. Even when one is initially unaware of historical ties between one’s home country and a host country, one may still be reminded of a collective history through the way one is perceived by foreign nationals. Similar effects have been suggested by cognitive psychologists such as Halbwachs ([1950] 1980) who—in relation to the idea of a collective memory—suggested that “a man must often appeal to others’ remembrances to evoke his own past” ([1950] 1980: 51). What this implies is that both directly and indirectly, historical ties may shape how one perceives (and is perceived by) foreign nationals. Similar to how stereotyping may give an (often


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incorrect) impression of familiarity with foreign nationals (recall for example the national German stereotype of Poles being lazy) historical ties therefore may positively affect the extent to which a foreign country is perceived as familiar. 5.4.3 Organizational responses to the disconfirmation of prior assumptions Internationalization process theory conceptualizes the internationalization process as a gradual and unidirectional ‘learning through experience’ process. The Altona case supports such a view; however, it also illustrates that internationalization as a learning process does not necessarily imply incremental internationalization processes. Commitment decisions were not postponed until Altona had gained a reasonable understanding of local markets. Instead, the above illustrated that strong assumptions and generalizations appear to have enabled the establishment of wholly owned subsidiaries in Hungary, Poland, and Russia early on. Over time, however, many of the assumptions which had initially informed Altona’s entry decisions proved incorrect, and initial beliefs had to be revised. The following sections illustrate the different organizational responses Altona employed to the disconfirmation of key assumptions in Hungary and Russia. An increase in autonomy for the Hungarian subsidiary Upon entry into Hungary, it was implicitly assumed that the characteristics of the newly formed independent newspaper market, as well as the characteristics of its future customer base, were relatively comparable to the German home market. This was reflected in the confidence placed in the extent to which Altona’s knowledge and expertise in the domestic market could be translated to the Hungarian market. With respect to the magazine business however, this resulted in severe underestimations of the lack of buying power of the local populace, and an underestimation of the extent to which content and style needed to be adapted to local consumer preferences. In addition, by attempting to extend its domestic experiences to the Hungarian market, Altona failed to recognize that competing in a market less concentrated than the domestic market required a larger degree of customer segmentation and product differentiation. It took a failed launch of its popular car magazine for Altona to learn that the initial assumption ‘what works well in the domestic market can be transferred with similar success to the Hungarian market’ did not hold. This resulted not only in adaptations of Altona’s product strategies, but also in several structural adaptations, such as a larger degree of autonomy for its Hungarian subsidiary and less direct involvement of Headquarters in local operations. A German manager involved in the early development of the Hungarian subsidiary recalls:


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“I very well remember the organization at that time at Altona, and the market itself or the development of markets. […] There was the idea to transfer the Autobahn brand to the Hungarian market and, well, we had to sit together with those guys who have been for Autobahn at that time […] so I remember a meeting when two guys from Hungary came, and I was the third guy who joined to that Hungarian team, and on the other side were sitting twenty people from the Autobahn Group. And it was all about Autobahn. So what can you do if you’re three against twenty. And I don’t want to say it was against, but you know, these twenty tell you about how Autobahn works in Germany, and what they would recommend how to build the brand, and so on and so on. And you sit there, and you think ‘Ok, nice to hear’, and ‘we think it is a good idea, brilliant’, and so on. And they convinced us to do it in this and that way, and we did it here in the Hungarian market, and it totally failed because it was the translation of the German approach to the Hungarian market. But the translation was only the language translation. All the other things like pricing, paper, page count, anything else was just identical with the German approach. And that killed us, because all the success factors of the German edition couldn’t be transferred via this approach. One example. Autobahn is the cheapest car magazine in the German market. But taking over all these parameters from the German business, this magazine was the most expensive magazine in the Hungarian market. Not only in the car market, but in the total market. So this magazine totally failed. And after that there was a kind of learning and a kind of change in the approach. The teams on the German side got much smaller, and the Hungarian teams became a little bit bigger, so the Hungarians got more and more the [dominant] position. And the more you know about your own market, the more self-conscious you are in bringing up arguments and facts and so on. So after a year it changed and it was no longer Altona Germany who said “OK, let’s do this” and “You should do that”. It was the Hungarians who said, “Ok we want to try this” and “We want to try that”.”

The experience with Autobahn strongly impacted the development of the Hungarian subsidiary. It disproved Altona’s implicit assumption that the Hungarian market could be treated as an extension of the domestic market. Instead, it signalled that in order to operate successfully in the Hungarian media market, clear knowledge of local conditions was required, as well as a much larger degree of local responsiveness and an excellent network of local contacts. In response, the local CEO was subsequently allowed to operate and develop the Hungarian subsidiary with a considerably higher degree of autonomy. In addition, less emphasis was put on the transfer of home-market knowledge and practices to the Hungarian subsidiary, and more emphasis was put on responding to local consumer preferences. Efforts were put in the development of a local printing facility, and several local magazine titles were developed.


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The resulting success of allowing the local subsidiary to operate with a larger degree of autonomy was such that the ‘Hungarian subsidiary model’, in which a well-networked autonomous CEO featured heavily, was eventually to be duplicated in Poland and Russia. The large degree of autonomy granted to these local subsidiaries translated for example into the adaptation of domestic titles and the development of local titles, the adaptation of advertisement strategies to local circumstances, and the execution of local market research; in essence shifting large parts of the value chain to the local markets. In the words of the Russian managing director, while “reporting is normal, for figures, ads sales, forecasts, and stuff like that, [everything else is] local. I share the results, for explanatory reasons. But media agencies, or with whom we work or what we’re doing, no.” In general, as another manager remarks,

“The learning from Hungary was that you have to know a lot about the country, it’s political system, the demand from the market, and so on. You can only live it and you can really experience it only if you are sitting in that country and if you know how the people are behaving, how the people are working, how the agencies are working, and so on. And this is absolutely a local business, so Altona thought: this approach here, with the CEO from the country itself who has all the contacts and so on, is the best way to do it. And therefore they skipped all the ideas to implement German specialists over time in the countries itself.”

Reconsideration of the mode of operation in Russia As discussed earlier, Altona’s entry strategy into the Russian market was largely based on the positive experiences in Poland and Hungary. A wholly owned subsidiary was decided on, and a local Russian CEO was attracted, on the assumption that the Russian market was in several respects comparable to the markets in Poland and Hungary. However, several of these assumptions, regarding for example distribution and the role of politics, gradually proved to be severe underestimations of Russia’s harsh business environment. While one would over time expect gradual increases in foreign market commitment due to the accumulation of local knowledge, the disconfirmation of several key assumptions led Altona to consider scaling back its operations in Russia, and to consider the formation of a partnership with a local partner to compensate for perceived knowledge deficiencies.

Upon entry in Russia, several statements of members of the management board, released through press releases and interviews in several media, made note of the vast size of the Russian market and of the growing middle class. Such statements illustrate the board’s ignorance of the complex distributional system in Russia, which the local managing director described as a “natural bottleneck”; both in terms of the size of the country and in terms of the sophistication of the distributional network. As a result, particularly due to overestimations of the extent to which weekly magazines could be


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distributed in a timely manner, sales in Russia were less than expected. As the local managing director explains:

“The print-runs are not reflecting the potential of the country, and that’s not because we cannot print more, or we have no paper, or no content, or no team, but no distribution. Bottlenecks in distribution. Everything that goes up to Ural is OK; everything in Siberia is getting tricky, especially for weekly titles.”

Altona only gradually came to realize that the Russian independent media industry was less developed than for example the Polish and Hungarian media market. Tax regulations, for example, were more complicated, especially with regard to remissions (unsold copies) on which taxes had to be paid nonetheless. Altona also encountered unforeseen difficulties in advertising magazines through rival media channels, as the following example illustrates:

“What I dislike is television stations sort of refusing despite of a running contract, to show our advertisement because they don’t like the cover, for example. We had it yesterday, the first channel refused to show our TV spot for ‘OK!’ because there was a pop star on the cover which is a star on the second television. ‘But guys, we have a contract, so…’ - ‘Yeah but she is not working with us’. So I said: ‘I’m enhancing in advertisement our product, not yours’. That’s the sort of misunderstanding, who is paying whom.” (Managing director Russia)

The relatively positive experiences in Poland and Hungary also resulted in underestimations regarding the role of politics in the Russian media industry. In a world where the interests of politics, business, and the independent media are often both closely aligned and conflicting, politics proved to have a surprisingly large bearing on Altona’s ability to, for example, independently pursue an acquisition strategy. The president for Central Eastern Europe drew frequent comparisons between Poland and Russia. The following statement is particularly illustrative in this regard.

“We looked in the [Russian] market for let’s say tabloids or newspapers overall […] and we see that is pretty difficult, and that we, unlike for example in Hungary or in Poland, if you approach a local company and say ‘If you wanted to sell, could we buy’, you feel that it’s more difficult; that it’s a political issue, always. […] In Russia, it’s like a wall at some point. And this we certainly underestimated. […] In Poland we simply took into consideration the market, but did we contact [local politicians]? No. We didn’t fear them, and I think we didn’t take them particular into consideration. But we can’t do this in Russia. Definitely.”


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Altona also learned the hard way that the thin line between politics and media implies that as one of the relatively few players in Moscow’s concentrated media landscape, Altona itself is constantly in the political limelight. This perhaps became most clear in 2006, when the December issue of one of its business magazines was initially suspended from distribution, following an article on the business interests in real estate of the wife of Moscow’s mayor. Amidst accusations of libel and the violation of journalistic ethics, Altona’s journalistic standards were widely questioned. Eventually, this experience underlined the unexpectedly short lines between business, politics, and media. The local managing director:

“The underestimation which I’ve learned painfully, and that was my personal underestimation as well, was how being in the media in Russia means you’re in the political limelight. One-hundred-and-fifty percent. That was a new experience for me in December. And this means high political limelight. […] This is a chain reaction which is not a local game, this is a game between lots and lots of different players and agendas.”

In response to the disconfirmation of many initial assumptions about the Russian market environment, Altona considered relinquishing direct control over its Russian operations. Newspaper articles appeared which claimed that Altona was looking to sell off its local subsidiary, but these reports were declined by several interviewees as incorrect. When asked whether in hindsight it would have been more convenient to enter the Russian market through a partnership rather than through a wholly owned subsidiary, the president for Southern and Eastern Europe did indicate that the formation a partnership in Russia was actually considered.

“It would have been easier to team up with a partner for business reasons. […] Which we still don’t exclude because we are always thinking and rethinking about our strategy. It might be that this is what we’re doing some day. Specifically because at some point it might be we want to launch or to acquire a newspaper. And then, for political reasons, probably, and also for business reasons it might be better to team up with a Russian partner.”

In addition to the political benefits of teaming up with a well-connected Russian partner, the formation of a partnership was seen as a possible solution to Altona’s distributional problems and to contribute to better regional access. Although Altona was still merely in the screening phase of identifying suitable partners, the formation of a partnership was perceived as a potentially more viable alternative to its wholly owned subsidiary.

In all, Altona’s accumulation of experiential knowledge was paralleled in several foreign markets by the disconfirmation and unlearning of many of the prior


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assumptions which initially affected Altona’s entry mode decisions. In Hungary, the local subsidiary gained much more autonomy when preconceptions about the generalizability of the home experiences to the foreign markets were disproved. In Russia, several assumptions about the nature of the Russian market, which largely stemmed from generalizations based on Altona’s prior experience in Poland, proved to be naive underestimations of the unorthodox Russian market environment. As a result, Altona considered scaling back its Russian activities by involving a local partner in its Russian operations. Therefore, while internationalization process theory predicts that actual experience gradually allows for more committed modes of foreign operation, Altona’s experience illustrates that the accumulation of actual knowledge can be preceded or paralleled by the disconfirmation of key assumptions, which may call for a variety of organizational responses.

5.5 Discussion

Below, I first discuss why Altona—contrary to what would be expected based on internationalization process theory—opted to enter several key markets in Central Eastern Europe through wholly owned subsidiaries rather than through less committed entry modes. I draw attention to the uncertainty-reducing effects of subjective beliefs and assumptions before, following the principle of theory triangulation (Patton, 1987), contrasting my interpretation of the case findings with alternative theories on international firm behaviour—transaction cost theory in particular. I end this discussion by proposing several adjustments of the internationalization process model, which are argued to increase both the explanatory power and the internal consistency of the model. In the second part of the discussion I focus on the question why the post-entry disconfirmation of key assumptions resulted in the reconsideration of the mode of operation in some markets, and the persistence of relatively committed modes of operation in others. I develop the argument that different organizational responses can be expected depending on whether the disconfirmed assumptions pertain to characteristics of the foreign market environment or to industry characteristics. 5.5.1 The uncertainty-reducing effect of assumptions and beliefs The Altona case illustrates the argument that the absence of knowledge may only impede the internationalization process of firms if the lack of local knowledge is not offset by vivid beliefs and preconceptions regarding the nature of foreign countries and markets. Key decisions at the time of the Hungarian entry, such as on the product strategy to be followed or the degree of autonomy to be granted to the local subsidiary, appear to have been strongly affected by assumptions of similarity between the German and the Hungarian media market. Entry decisions in Poland and, in


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particular, Russia instead proved to be strongly based on the generalization of local market conditions encountered in previously entered markets. Such generalizations, which ranged from assumptions regarding local business mentalities and consumer preferences to assumptions regarding the level of development of the local distribution system, appear to have had a large bearing on the decisions to establish full subsidiaries early on.

The observation that key decisions were repeatedly based on subjective representations rather than on actual knowledge of local markets illustrates that internationalization process theory may so far have overlooked an important element of human decision-making; namely that in the absence of actual knowledge, decisions can instead be based on unsubstantiated beliefs and assumptions. As others have argued, the beliefs one holds do not have to be true in order to affect decisions (Markóczy, 1997; Simon, 1947; 1991), and subjective beliefs about the nature of a foreign market—however unrealistic they may be—may strongly influence the extent to which key decision makers perceive a foreign market as familiar. As such, both knowledge and beliefs are likely to have a direct bearing on the subsequent uncertainty experienced by foreign entrants.

A parallel can be drawn with Tsang’s (2004) study on the effect of superstitious beliefs on decision-making by Chinese managers. Tsang found that about three-quarters of his respondents relied on some form of superstition—ranging from hiring feng shui experts to consulting oracles—when faced with high uncertainty due to a lack of information. Tsang relates his finding to Malinowski’s (1948) theory on the role of superstition in societies, which posits that “superstition serves to fill the void of the unknown and to reduce anxiety” (Tsang, 2004: 96). The current study and for example the study of Calof (1993) suggest that subjective beliefs about the nature of a foreign market can be expected to have a similar effect on the perceived uncertainty towards foreign markets and foreign host contexts.

This implies that if we are to conceive the internationalization process of firms as a ‘learning through experience’ process (O’Grady and Lane, 1996), merely taking into account explicit and experiential knowledge does not suffice. Instead, we need to acknowledge that unsubstantiated beliefs and assumptions form a substantial part of the cognitive base of key decision-makers and, as the case illustrates, that subjective perceptions of foreign markets may therefore have a large bearing on initial internationalization decisions. For example, firms which perceive new foreign markets as relatively familiar due to vivid beliefs on the nature of a foreign market environment can be expected to demonstrate relatively high levels of local involvement even upon entry. In other words, a firm’s degree of market commitment may be proportional to the perception of familiarity with a foreign market environment, rather than merely to the stock of actual knowledge as internationalization process theory suggests. Taking into account both subjective beliefs and actual knowledge not only corresponds more closely with the cognitive


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perspective which is already implicit in internationalization process theory, it may also extend the explanatory power of the internationalization process model to empirical observations which internationalization process theory was previously unable to account for, such as foreign market entries through wholly owned subsidiaries rather than through exporting and licensing. Alternative theoretical perspectives The dominant alternatives to the internationalization process model with respect to entry mode selection are the knowledge-based perspective, internalization theory, and the eclectic paradigm. From the perspective of the knowledge-based theory of the firm, the mode of entry is largely determined by the nature of the know-how to be transferred. The MNE is viewed as a mechanism to transfer particularly tacit knowledge across borders (Tallman, 2003), and foreign expansion is driven by the competitive capabilities of firms to successfully create, replicate, and transfer knowledge (Kogut and Zander, 1993). In a similar vein, firms with a strong technological base and a rich knowledge structure are predicted to expand internationally through start-ups rather than through acquisitions (Barkema and Vermeulen, 1998). Therefore, from the perspective of the knowledge-based theory of the firm, wholly owned subsidiaries are expected when the competitive capabilities of a firm abroad are relatively dependent on the transfer of skills and knowledge from the domestic market to the foreign market. Yet, the publishing industry was consistently described as strongly a “local business” which among others is reflected in the importance Altona attaches to well-networked local CEOs. On the basis of the knowledge-based theory of the firm, we would therefore expect an internationalization strategy which relies more heavily on licensing than on the establishment of wholly owned subsidiaries.

Both internalization theory and the eclectic paradigm essentially apply transaction cost theory (TCT) arguments with regard to entry mode selection. From a transaction cost perspective (Williamson, 1981), the commitment of resources to a foreign market is interpreted as a sign of market failure, as committed entry modes indicate that the costs of monitoring market-transactions exceed the costs of setting up and maintaining appropriate governance structures to coordinate a firm’s operations abroad. From a transaction cost perspective, Anderson and Gatignon (1986) explain, four constructs positively affect whether a considerable degree of control is desired: asset specificity, the combined effect of asset specificity and external uncertainty, internal uncertainty, and the potential for free riding by potential business partners. Based on transaction cost theory, we would expect committed modes of entry under the following conditions:


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1) when asset-specificity is high, 2) when both asset-specificity and external uncertainty are high, 3) when internal uncertainty is high, or 4) when the potential for free-riding on the basis of the brand name of the

entrant is high. Given that neither asset-specificity nor the potential for free-riding are high (note that Altona licenses titles to smaller markets such as Serbia and Latvia), on the basis of transaction cost theory one would only expect the selection of wholly owned subsidiaries in Poland, Hungary, and Russia if internal uncertainty toward these markets is high.

However, as Anderson and Gatignon note, on the basis of transaction cost theory, two alternative responses can be expected when firms are faced with high internal uncertainty. As they explain, “[i]nternal uncertainty exists when the firm cannot accurately assess its agents’ performance by objective, readily available output measures” (1986: 15). Under such circumstances, high control is needed to monitor inputs rather than outputs, which favours a relatively committed form of foreign entry such as a wholly owned subsidiary. On the other hand, “[t]he international neophyte fears the unknown, consequently overstating risks and understating returns of international markets (Davidson, 1980)” (1986: 16). Anderson and Gatignon therefore suggest that it can also be argued that internal uncertainty reduces the propensity of firms to commit the resources needed to set up and maintain more appropriate governance structures. With experience, Anderson and Gatignon argue, firms enhance their “understanding, competence, and confidence” (1986: 16), and the desired degree of control of a foreign business entity increases. Note that this is essentially the argument put forward by internationalization process theorists in the mid-1970s (Johanson and Wiedersheim-Paul, 1975; Johanson and Vahlne, 1977). As Johanson and Vahlne (1990) note, their argument therefore is, essentially, a transaction cost argument. 5.5.2 Organizational responses to the disconfirmation of key assumptions and beliefs While unsubstantiated beliefs and assumptions may often inform key internationalization decisions—recall Calof’s (1993) observation that 39% of the mode change decisions in his sample were based entirely on gut feel—most of such beliefs are essentially incorrect representations of a foreign market environment. This draws attention to the question what organizational responses MNEs employ in dealing with emerging or exposed knowledge deficiencies when important initial assumptions are disconfirmed. The Altona case illustrates two alternative organizational responses when significant assumptions prove incorrect: adaptation of the degree of market commitment (I), as was considered for the Russian subsidiary, or


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(II) structural and strategic adaptation as observed at the Hungarian subsidiary. The argument developed here is that the subsequent selection of one response over the other is dependent on whether the firm experiences a discrepancy between the foreign market environment and the subjective perception of that environment, or whether the firm experiences a discrepancy between the strategic requirements of the industry and the firm’s international model. I: Adaptation of the degree of market commitment Internationalization process theory conceptualizes a firm’s involvement in foreign markets as a process which evolves out of the interplay between the commitment of resources on the one hand, and the accumulation of knowledge on the other (Johanson and Vahlne, 1977). Since the commitment of resources enables the accumulation of additional knowledge through experiential learning, the internationalization process is conceptualized as a strictly cumulative process, and disinvestments remain unaccounted for (Calof and Beamish, 1995). However, Altona’s Russian entry illustrates that when initial preconceptions are disproved and the accumulation of experiential knowledge has yet to take place, decision-makers may respond by limiting the firm’s exposure to the foreign market environment in response to the increased uncertainty and risks experienced towards that market.6

This expectation requires that the disconfirmation of incorrect beliefs precedes—rather than parallels—the actual accumulation of local knowledge. This seems reasonable. In the Altona case, the recognition that several key assumptions did not hold in Russia did not automatically translate in alternative solutions to, for example, the distributional problems experienced outside Moscow. In a similar vein, Pedersen and Petersen (2004) found that expatriates’ self-reported understanding of the foreign context in which they operated, over time followed a U-shaped curve rather than a linear increase. Their finding suggests that the disconfirmation and rejection of (perhaps overly simplistic) initial representations of foreign contexts proceeds rather than parallels their actual understanding.

Analogous to how a decrease in the uncertainty experienced towards a foreign market environment may induce firms to increase their degree of foreign involvement (Johanson and Wiedersheim-Paul, 1975, Johanson and Vahlne, 1977), a significant increase in uncertainty as a result of exposed knowledge deficiencies may therefore lead firms to reduce the degree of market commitment and exposure to the foreign market environment to levels which are more in correspondence with the associated risks. The Altona case illustrates that firms may do so by either scaling back the mode

6 Indeed, when several key assumptions about the Russian market environment proved incorrect, attempts were made both to sell off Altona’s local subsidiary to a competitor, and to involve a local partner to compensate for the experienced lack of knowledge and experience.


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of operation—which in the case of Altona would open up the possibility to resolve the experienced knowledge deficiencies through the involvement of a local partner—or by reducing the firm’s degree of resource commitment. II: Adaptation of the MNE model Altona’s organizational response to the disconfirmation of key assumptions in Hungary differed markedly from Altona’s organizational response to the disconfirmation of preconceptions about the foreign market environment in Russia. Whereas in Russia, Altona reacted by considering various forms through which its direct involvement in the Russian media market could be reduced, in Hungary Altona implemented several significant structural and strategic changes. Less emphasis was put on the transfer of home-market knowledge and practices to the Hungarian subsidiary, and the degree of autonomy for the local CEO increased considerably. Similarly, products were no longer modelled directly after German publications but were rather developed locally, which resulted in several new titles. As a result, the Hungarian subsidiary was able to become much more responsive to local consumer preferences and local market considerations.

In order to understand why Altona’s organizational response to the disconfir-mation of initial assumptions differed between Hungary and Russia, we need to take into consideration what these initial assumptions and beliefs pertained to. In Russia, most preconceptions were essentially generalizations of characteristics of the market environments Altona had already encountered in most of Central Eastern Europe, and Poland and Hungary in particular. These initial beliefs and assumptions referred for example to local negotiation styles and business cultures, the role of politics in the Russian media industry, and the state of development of local distribution systems.

Instead, the assumption that ‘what had worked well in the German home market can be transferred to the less developed Hungarian media market’ should not be considered as an assumption about the Hungarian market environment in particular, but rather as an assumption concerning the strategic requirements of the media industry in general. What Altona’s failed launch of its leading car magazine underlined was that the success of its international activities was not dependent on the extent to which its superior publishing expertise could be transferred to local markets, but rather on the extent to which formats, layouts, and content could be adapted to local consumer preferences, and on the extent to which production and distribution could be successfully adapted to local conditions and regulations.

In essence, therefore, Altona’s organizational response in Hungary was a response to disconfirmed assumptions about the strategic requirements of the publishing industry. The emphasis on the transfer of know-how and expertise to the local subsidiary, which is characteristic of the international MNE model (Bartlett and Ghoshal, 1988), was replaced by an emphasis on local responsiveness. Similarly,


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relatively tight links between headquarters and the local subsidiary were replaced by the decentralization of key decisions and responsibilities, and by a significant degree of local managerial autonomy. This signals a shift towards the multinational MNE model which better reflected the demands posed by the publishing industry.7 The resulting success was such that ‘the Hungarian model’, as it became known internally, was eventually replicated when Altona established subsidiaries in Poland and Russia. The interdependence between un-learning and MNE response In the discussion above, I indicated how acknowledging the role of subjective beliefs and assumptions in key internationalization decisions also draws attention to the organizational responses MNEs employ when key assumptions prove incorrect. The fact that this topic has received little attention in the IB literature is not surprising. In the dominant conceptualization of the internationalization process (Johanson and Vahlne, 1977; 1990), initial preconceptions play a marginal role, as commitment decisions are presumed to be based on a sound understanding of local market conditions (and are even postponed in the case of a lack thereof). On the other hand, studies which focus on adaptation and change of MNEs often do so in the context of changing environmental pressures (e.g. Buckley and Ghauri, 2004, Bartlett and Ghoshal, 1988) rather than in the context of the dynamics of internationalization processes.

The argument developed above is that the organizational response of MNEs when key assumptions prove incorrect is largely contingent on what the disconfirmed assumptions and beliefs in question pertained to. Whereas the disconfirmation of key assumptions about the strategic requirements of the industry is likely to result in an adjustment of the firm’s organizational and strategic capabilities rather than in a change in local market commitment, a change in market commitment—be it in terms of resource allocation or mode of operation—is a more probable response to the increased uncertainty experienced when key assumptions about the nature of the foreign market environment prove incorrect.

The distinction between assumptions which pertain to the strategic requirements of the industry and those which pertain to the foreign market environment to some extent reflects the common distinction in internationalization process theory between (location-bound) local market knowledge, and (non-location-bound) internationali-zation knowledge (Carlson, 1966; Johanson and Wiedersheim-Paul, 1975; Johanson and Vahlne, 1977; Eriksson et al., 1997). However, neither the classification of assumptions above, nor the identified MNE responses are meant to be exhaustive. For example, Eriksson et al. (1997) further divide local market knowledge into foreign

7 What appears to have facilitated this change in MNE model was that Altona’s international organization was relatively unburdened and unconstrained by administrative heritage.


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business knowledge and foreign institutional knowledge, and the appropriate MNE response to exposed knowledge deficiencies may differ accordingly.

For the purpose of this study, however, this initial distinction—between assumptions pertaining to the strategic requirements of the industry and those pertaining to the foreign market environment—suffices. It illustrates that considering subjective beliefs potentially extends the explanatory power of internationalization process theory, not only to high-commitment entry decisions, but also to subsequent decreases in foreign market commitment. While such reductions in market commitment have not received much attention in the literature (Agndal and Chetty, 2007), they are commonplace. For example, Calof and Beamish (1995) found that 23% of the mode changes in their sample involved decreases rather than increases in the degree of market commitment. Although such dynamics have recently drawn the attention of several scholars (e.g. Agndal and Chetty, 2007; Chetty and Agndal, 2007; Pedersen, Petersen, and Benito, 2002) reductions in market commitment are not often explicitly framed within the context of internationalization process theory.

Table 5.1: The hypothesized interdependence between unlearning and MNE response

Disconfirmed assumptions pertain to: MNE response

Strategic industry requirements Adjustment MNE model

Foreign market environment Adaptation foreign market commitment

5.6 Conclusion Internationalization process theory continues to be frequently criticized for its inability to explain the internationalization of firms through relatively committed entry modes, such as wholly owned subsidiaries (Andersen, 1993; Axinn and Matthyssens, 2002; Steen and Liesch, 2007; Zhou, 2007). In addition, Forsgren (2002) and others have noted that by emphasizing the importance of experiential learning, internationalization process theory has largely disregarded alternative forms of cognitive learning. As a result, the explanatory power of internationalization process theory and the idea of internationalization as an incremental ‘learning through experience’ process have been repeatedly called into question.

In the light of such criticism, the aim of this chapter has first of all been to address a conceptual issue of the internationalization process model in the relation between


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knowledge and uncertainty, which has limited the explanatory power of internationalization process theory. Internationalization process theory assumes that the uncertainty experienced by internationalizing firms stems primarily from a lack of knowledge of foreign markets, and from a lack of internationalization knowledge (Johanson and Vahlne, 1977; 1990; Eriksson et al., 1997). Yet in addition to the limited actual knowledge decision makers initially have of foreign markets, subjective beliefs and assumptions make up the knowledge structure of organizational members on which organizational decisions—such as entry and location decisions—are based (Markóczy, 1997). As the case study illustrated, in the absence of actual knowledge, entry and location decisions may therefore instead be based on subjective assumptions and generalizations about the nature of foreign markets. Such prior beliefs appear to have reduced some of the initial uncertainty Altona experienced towards the markets in Central Eastern Europe, which can explain the selection of high-commitment entry modes. It is likely that more realistic assessments can be made about international firm behaviour if we conceptualize internationalization as a process in which the accumulation of experiential knowledge is accompanied by the gradual disconfirmation and unlearning of prior beliefs and assumptions. In addition to addressing this conceptual issue, I also aimed to draw attention to the question how MNEs respond to the disconfirmation and unlearning of key assumptions and beliefs. Biased and incorrect assumptions and beliefs are not only commonplace in the boardrooms where key internationalization decisions are made (Calof, 1993; Calof and Beamish, 1995); they may also have severe performance implications. For example, in their well-known study on the ‘psychic distance paradox’, O’Grady and Lane (1996) found that incorrect assumptions about the degree of similarity between the United States and Canada accounted for the surprisingly low performance in the US of the Canadian retail firms in their sample. The Altona case illustrated that how MNEs respond to the disconfirmation of such key assumptions may well be dependent on whether these disconfirmed assumptions and unlearned beliefs pertain to characteristics of the foreign market environment, or to the strategic requirements of the industry at large.

In all, incorporating subjective beliefs and assumptions into behavioural models of the internationalization process of firms makes almost intuitive sense, yet the implications are potentially far-reaching. It implies that the considerable commitment of resources to foreign markets early on can—at least on occasion—be explained from a learning perspective by pointing to the uncertainty-reducing effects of prior assumptions and beliefs. This greatly extends the explanatory potential of internationalization process theory beyond strictly incremental internationalization processes. In addition, the conceptualization developed here of internationalization as an experiential learning and unlearning process provides a behavioural explanation for the commonly observed reductions in market commitment, such as mode changes


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to less committed modes of operation, which internationalization process theory has been unable to account for (Calof and Beamish, 1995).

The results of this study suggests several lines of further inquiry. For example, while the role of experiential knowledge in the unfolding internationalization process of firms has received due attention (e.g. Erramilli, 1991; Eriksson et al., 1997; 2000), subjective beliefs about foreign contexts have so far been rarely considered. The argument developed here paves the way for a closer examination of behavioural explanations in our understanding of both entry mode decisions—often solely perceived from a transaction cost perspective—and subsequent shifts in the mode of operation. Several other studies provide support for pursuing such lines of inquiry. Calof (1993) and Calof and Beamish (1995) have emphasized the apparent lack of rationality of executives involved in decisions regarding mode change (Calof, 1993), and the subjectivity of perceived market attractiveness (Calof and Beamish, 1995). Pedersen and Petersen (2004) counter-intuitively observed an initial decrease in the extent to which expatriates are familiar with foreign markets, a seemingly paradoxical phenomenon they labelled the ‘entry shock effect’. The questions which such studies and the current study raise, deserve to be explored before we are to discard internationalization process theory as an outdated model of international firm behaviour.

Chapter 6

Conclusions and recommendations for future research

6.1 Introduction

The studies in this book draw attention to two key assumptions of inter-nationalization process models: First, the notion that country differences are the main antecedent to the perception of psychic distance; or, phrased differently, that the degree of uncertainty experienced towards foreign market environments is dependent on the extent to which foreign contexts differ from a firm’s home context. And second, the notion that market and resource commitments are based on decision makers’ actual knowledge and understanding of local markets. It is these assumptions which lead internationalization theorists to conceptualize the internationalization process as the gradual expansion into increasingly more different countries, paralleled by a gradual deepening of a firm’s involvement in those markets in which the firm is already active.

The studies in this book paint a somewhat different picture of the processes underlying internationalization; one in which both knowledge and the subjective beliefs affecting the perception of foreign market environments feature more prominently. Following a conceptual critique of the internationalization process model in Chapter 2, and the development of an index of institutional country differences in Chapter 3, Chapter 4 focused on the factors affecting location decisions. The effect on the location of foreign investment of various country differences associated with reduced psychic distance was contrasted with that of historical ties, a variable associated with familiarity perceptions. Chapter 5 presented the case study of a major German publishing house. The case study explored the effect of familiarity perceptions on individual entry decisions, and focused on the counter-intuitive selection and persistence of high-commitment entry modes in markets of which the German publishing house had very little prior knowledge. This final chapter provides a short summary of the findings and ties together the conclusions that can be drawn


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from the separate studies. The closing sections suggest several potential avenues for future research.

6.2 Summary of the findings

Foreign market selection In Chapter 4 it was argued that in emphasizing the effect of country differences, internationalization process theory overlooks an important dimension of psychic distance. In particular, what determines the perception of psychic distance—and subsequently foreign market selection—is not merely the degree of similarity between the home and the foreign country, but also the extent to which a foreign market environment is perceived as familiar. The familiarity argument builds on the idea that the perceived understanding of foreign markets and foreign host contexts depends not only on actual knowledge and information, but also on the unsubstantiated beliefs, assumptions, and generalizations that are held to be true. Implicit beliefs and assumptions may therefore drastically reduce the uncertainty associated with foreign resource commitments, even when the decision maker lacks actual knowledge, and actual differences exist between countries.

The validity of this argument was explored by contrasting the effect of historical ties—a variable associated with familiarity perceptions—with that of country differences on the location of foreign direct investment from the UK, France, Germany, and the Netherlands, over a twenty-year period. The effect of historical ties, common language, and industrial development on investment location proved highly significant, but no support emerged for the idea that firms favour investments in culturally, institutionally, politically, religiously, or educationally similar countries. The establishment of an effect of historical ties—independent of the degree of similarity between countries—provides support for the familiarity hypothesis and challenges the assumption that the degree of uncertainty experienced towards foreign markets is mainly dependent on country differences.

This study is not the first to scrutinize the effect of country differences on location choice. But most studies have traditionally interpreted weak empirical support as evidence against the notion of psychic distance, rather than against its alleged antecedents. Instead, the empirical results in this study illustrate that an important dimension of psychic distance, the perception of familiarity, may have been overlooked. In addition, the results suggest that not all country differences may have equal weight as a psychic distance stimulus. This adds to studies which have emphasized the importance of perception in measuring psychic distance (Dow, 2000; although with some emphasis on perceived country differences), or the importance of considering actual information sources (Brewer, 2007).

Chapter 6: Conclusions

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Foreign market commitment The case study in Chapter 5 suggests that familiarity perceptions may similarly affect decisions on the development of a firm’s operations within foreign markets. Internationalization process theory views a lack of knowledge as one of the key impediments to the internationalization process of firms. Yet the case study illustrated that internationalization process theory may have neglected that in the absence of local knowledge, internationalization decisions may instead be based on unsubstantiated beliefs and assumptions on the nature of foreign market environments, which increase familiarity perceptions. Therefore, similar to how superstitious beliefs may “fill the void of the unknown and […] reduce anxiety” (Tsang, 2004: 96), strong beliefs and assumptions on foreign market environments may reduce some of the risks and uncertainty associated with entering new markets. This, I argued, may explain the selection of high-commitment entry-modes in foreign markets of which the firm has little actual knowledge.

The case study in Chapter 5 thus adds to a small number of studies which challenge the assumption that commitment decisions are primarily based on the actual knowledge firms have of foreign markets. Perhaps most significant in this regard are the contributions by Jonathan Calof (Calof, 1993; and Calof and Beamish, 1995), who observed that 39% of the mode-change decisions in his sample were primarily based on gut feel and subjective beliefs about the foreign market environment, whereas another 28% of these decisions were based on a combination of both gut feel and rational decision making (Calof, 1993). Both the work of Calof and Chapter 5 illustrate that in emphasizing the importance of experiential knowledge, internationalization process theory may have largely overlooked the effects of subjective beliefs on internationalization decisions. MNE responses to unlearning In addition, this study draws attention to the potential implications of (cultural) learning processes; or more specifically, to what happens when initial beliefs and key assumptions are disconfirmed. The alternative responses to unlearning noted in the case study in Chapter 5 suggest that the MNE’s response to unlearning may well be contingent on whether the disconfirmed assumptions pertain to the strategic requirements of the industry or to the nature of the foreign host context: While the disconfirmation of key assumptions on the strategic requirements of the industry is likely to result in an adjustment of the MNE’s organizational model, a change in market commitment is a more probable response when key assumptions about the nature of the foreign host context prove incorrect.

MNE responses to exposed knowledge deficiencies have so far received little attention in the IB literature, especially in contrast to, for example, MNE responses to


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changing environmental pressures (e.g. Buckley and Ghauri, 2004; Bartlett and Ghoshal, 1989). Similarly, while the literature on internationalization knowledge has examined the effect of internationalization on the accumulation of different types of experiential knowledge (e.g. Eriksson et al., 1997; 2000), there have been few attempts to link the effect of different types of knowledge back to variation in internationalization decisions. By drawing attention to the alternative responses to different types of unlearning processes, the case study opens up interesting new avenues for future studies.

But perhaps most interestingly, Chapter 5 draws attention to the interrelated nature of internationalization decisions. In International Business studies, there is a tendency to consider internationalization decisions separately; such as entry-mode selection or, as in Chapter 4, the location of foreign investment. In contrast, Chapter 5 illustrated that the persistence of relatively committed modes of operation may be better understood when changes in the MNE’s organizational model are considered. It may well be that other internationalization decisions—rarely taken in isolation—prove to be similarly interdependent.

6.3 Foreign market familiarity: implications for internationalization process models

What emerges from the findings is that in addition to a lack of resources, the most important impediment to internationalization may be the uncertainty internationalizing firms experience due to the perceived lack of familiarity with foreign host contexts and organizing foreign operations. This suggests that apart from the perceived attractiveness of foreign markets, the internationalization process of firms is driven by the extent to which foreign markets are perceived as familiar, which reduces the risk and uncertainty associated with foreign market commitments. This notion advances the work of internationalization process theorists in that internationalization decisions may not only be based on the limited (experiential) knowledge decision-makers have (Johanson and Wiedersheim-Paul, 1975; Johanson and Vahlne, 1977) but also on the beliefs which decision-makers hold to be true on the nature of foreign markets, and on the appropriate ways to organize a firm’s foreign operations.

This notion finds support in empirical studies (Calof, 1993; Calof and Beamish, 1995) as well as in the behavioural literature on which internationalization process theory builds. For example, Aharoni (1966) observes how ethnocentric beliefs may affect the perceived attractiveness of investing internationally, and that “[t]he fact that some of these beliefs are incorrect, exaggerated, or based on half truth is not important when one deals with the decision-making process. The important thing is that people believe them to be true” (Aharoni, 1966: 96). Similarly, the concept of bounded or subjective rationality implies that decision-makers act both on the limited knowledge that is available and on the boundary of this information-space, which


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contains both the beliefs that are held to be true and the assumptions that have to be made (March and Simon, 1958; Simon, 1991). One of the objectives of this book has been to argue and illustrate that incorporating these notions into internationalization models changes the internationalization patterns which can be expected.

First, instead of selecting foreign country markets which are most similar to the home country, international neophytes may start in country markets which are perceived as relatively familiar. Through international experience, firms subsequently become more knowledgeable on how to manage their international operations and become adept at understanding new country markets (Eriksson et al., 1997; 2000). This can be expected to reduce some of the risk and uncertainty experienced towards less familiar country markets, stimulating subsequent market entries. Second, attributing a more central role to the perception of host country familiarity implies that even from a behavioural perspective, the notion of foreign market incrementalism does not necessarily hold. Strong beliefs, assumptions, generalizations and prejudices on the nature of a foreign host context may permit considerable market commitments despite a lack of actual knowledge of the foreign market environment and the foreign host context.

What does not change, however, is the importance of experiential learning in understanding internationalization processes. While a variety of factors may give rise to perceptions of foreign market familiarity, beliefs and assumptions are no substitute to actual knowledge and a real understanding of foreign markets and foreign contexts, which requires local experience (Johanson and Wiedersheim-Paul, 1975; Johanson and Vahlne, 1977). And while familiarity perceptions may facilitate foreign entries into countries that differ markedly from the home country, the performance implications may be dire if the perception of familiarity stems from false beliefs rather than actual knowledge (see O’Grady and Lane, 1996).

If anything, however, the studies in this book perhaps best illustrate that the behavioural dynamics that shape internationalization patterns are far from simple and straightforward; a fact which is too often overlooked in overly specialized IB studies. Whether and what country differences serve as antecedents to the perception of psychic distance may differ depending on entry mode (Chapter 4), and internationalization involves both the gradual accumulation of experiential knowledge, and the disconfirmation, rejection and unlearning of false beliefs which earlier may have guided internationalization decisions (Chapter 5). Similarly, the response of MNEs when false beliefs are disconfirmed may differ depending on whether the false beliefs pertain to foreign market characteristics or to strategic industry requirements. Therefore, contrary to some suggestions, I believe that inter-nationalization process theory should not be discarded as an outdated model of international firm behaviour, but that it provides fertile ground for future research.


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6.4 Research limitations

There are some obvious limitations to the conclusions that can be drawn. A first limitation stems from the use of country-level data in the study on the location of foreign investment (Chapter 4). What sets apart internationalization process theory from other theories on internationalization in International Business is the emphasis on the dynamics or processes underlying internationalization patterns. Yet the use of country-level rather than firm-level data implies that the effect of the familiarity variable—historical ties—on internationalization sequence cannot be commented on. To some extent, the case study corrects for this lack of attention to process, but the specific focus of the case study is on the development of local market-commitments rather than on foreign market selection.

A related limitation is that data on foreign direct investments does not capture the various forms of non-equity-based foreign market involvement, such as licensing or exporting. Therefore, as discussed in Chapter 4, the results may merely hold for a particular type of internationalization decision. A comparison of the results of Chapter 4 with the results of Dow and Karunaratna (2006), who use trade intensity as their dependent variable, illustrates that the relative contribution of various psychic distance stimuli may differ, depending on the entry mode decision (see Chapter 4).

However, even though using foreign direct investments to study location decisions is not necessarily perfect, there are also clear advantages of analyzing foreign direct investments over individual location decisions. As direct investments are the aggregate of location decisions multiplied by invested volume—or weighted location decisions as it were—it is arguably a more appropriate measure for the propensity of firms to overcome distance than the indiscriminate analysis of unweighted location decisions. In other words, it is actually quite appropriate to test a hypothesis derived from decision theory by addressing bundles of identical decisions weighted by volume.

A final limitation has to do with the generalizability of the case findings in Chapter 5. The embedded case study of the internationalization process of a German publishing house is illustrative, as it concerns a typical case in which a firm’s involvement in new foreign markets does not progress gradually. In addition, the case study illustratively demonstrated two alternative adaptive processes to unlearning. Yet the case study methodology also gives rise to the question to what extent the case findings can be generalized. On the basis of an embedded case study, no generalized statements can be made on the effect of familiarity perceptions on entry mode selection, or on the extent to which the response of MNEs to the disconfirmation of false beliefs is contingent on knowledge-type. Rather, the conclusions that can be drawn based on the case findings can only be generalized to tentative propositions, each of which requires future study.


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6.5 Directions for future research

While the role of experiential knowledge in the unfolding internationalization process of firms has received due attention (e.g. Erramilli, 1991; Eriksson et al., 1997; 2000), subjective beliefs about foreign contexts have so far been rarely considered. The familiarity argument developed in this book paves the way for a closer examination of behavioural explanations in our understanding of both entry mode decisions and subsequent shifts in the mode of operation. In terms of future research directions, a first line of research should therefore focus on examining the key antecedents to perceptions of host country familiarity. This may lead to better—more direct—indicators of familiarity perceptions than the historical ties proxy used in Chapter 4. Individual ties, social networks, and media coverage for example, are just some of the factors which may further affect familiarity perceptions.

Second, the studies in this book motivate additional studies on the effect of familiarity perceptions on internationalization decisions—in particular in relation to the effect of country differences. Comparing the findings of Chapter 4 with the results of Dow and Karunaratna (2006) suggests that while language influences investment decisions, common language is not similarly conducive to trade. In similar vein, the results of Chapter 4 suggest that familiarity perceptions affect foreign investment decisions. However, the question whether familiarity perceptions also affect non-equity-based entry mode decisions remains unanswered. As discussed in Chapter 4, such issues fuel further interest in the question what psychic distance stimuli matter with what entry mode decision.

Another question that is largely left unanswered is the extent to which familiarity perceptions affect the internationalization sequence of firms, or the order in which foreign markets are entered. The study on location decisions in Chapter 4 makes use of country-level data. As such, the level of analysis makes it impossible to comment on the effect of historical ties on the actual internationalization sequence of individual firms, or on the commitment of resources to foreign markets over time. As internationalization process theory is particularly concerned with the processes by which firms internationalize, I encourage future studies employing firm-level data to examine the effect of familiarity perceptions on internationalization sequence.

Future research should also focus on the performance implications of incorrect familiarity perceptions. As suggested throughout this book, familiarity perceptions may stem just as well from subjective beliefs and assumptions as from an actual understanding of foreign host contexts. This raises the question to what extent poor international performance can be attributed to incorrect representations of foreign host contexts. Several earlier studies have addressed the relation between psychic distance and international firm performance, such as O’Grady and Lane (1996), Evans and Mavondo (2002), and Evans, Mavondo, and Bridson (2008). This line of research


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may benefit from the conceptual differentiation between potential drivers of psychic distance perceptions proposed here.

Perhaps the timeliest of these research questions are related to the antecedents of psychic distance. Following the persistent use of cultural distance as the most commonly applied psychic distance surrogate, the last decade has seen considerable debate over how psychic distance can be measured. In Chapter 4 I argued that both a proper conceptualization and operationalization are first requirements to assessing the extent to which psychic distance affects internationalization processes. As it stands, it has been emphasized that psychic distance refers to perceptions (Dow, 2000), and that both actual information sources (Brewer, 2007) and subjective beliefs (Chapter 4) are more likely antecedents to such perceptions than mere country differences. In the actual measurement of psychic distance perceptions I see a clear role for psychometricians, while additional research should establish the extent to which individual psychic distance perceptions can be generalized to the organizational or country level.

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Appendices


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Appendices

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Appendix A: Institutional indicators and corresponding questions Institutional indicators in the Global Competitiveness Report 2000a

Corresponding questions in the Executive Opinion Surveyb

The state

Independence of policies (3.05) Government economic policies are independent of pressure from special interest groups.

Government subsidies (3.03) Government subsidies are directed towards improving the competitive environment.

Pervasiveness of clusters (10.16) Clusters are present in most international industries and include not only suppliers, but specialized institutions such as university research programs and training providers.

Burden of regulation (3.01) Burdensome administrative regulations are not pervasive.

Financial systems Access to external finance (8.04) Companies typically obtain outside financing for

investments from banks or the bond market. Stock market (8.11) Companies can raise money by issuing shares on

the local stock market. Skill development and control system Difference in quality of schools (6.02) The difference in the quality of schools available to

rich and poor children is small. Union power (6.10) Union power and influence is low. Trust and authority relations Public trust of politicians (4.16) Public trust in the financial honesty of politicians

is very high. Delegation of authority (11.13) Willingness to delegate authority to subordinates

is high. Management/worker relations (6.09) Management/worker relations are generally

cooperative. aCorresponding items in the Global Competitiveness Report 2000 are in parentheses. bRespondents were asked to indicate their agreement with each statement using a seven-point Likert scale (1=strongly disagree; 7=strongly agree).


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Appendices

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Appendix B: Institutional distances (averaged squared Euclidean distance)


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Appendices

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Appendices

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Appendix C: Institutional distances (Euclidean distance)


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Appendices

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Appendices

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Appendix D: Descriptives and gravity estimations for 1984–88, 1989–93, and 1994–98

Descriptive statistics and correlation matrix 1984–1988

Variables N Mean s.d. 1 2 3 4 5

1. FDI 1984-1988 149 5.64 2.23

2. National Incomes 1984

149 25.30 1.52 0.65**

3. Distance 149 8.17 1.20 -0.41** -0.27**

4. Historical Ties 149 0.15 0.36 0.28** 0.09 -0.10

5. Common Language

149 0.09 0.29 0.26** 0.00 -0.05 0.56**

6. Cultural Distance 149 0.37 0.92 -0.36** -0.33** 0.28** -0.16 -0.27**

* p < 0.05. **p < 0.01.



1. FDI 1989-1993 192 5.91 2.43


192 25.42 1.52 0.62**

3. Distance 192 8.25 1.14 -0.44** -0.31**

4. Historical Ties 192 0.15 0.35 0.31** 0.10 -0.10

5. Common Language 192 0.10 0.30 0.29** 0.02 -0.09 0.60**

6. Cultural Distance 192 0.43 0.89 -0.36** -0.30** 0.30** -0.17 -0.30**

* p < 0.05. **p < 0.01.


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Results of the gravity model for FDI location between 1984 and 1988

Independent variables Dependent variable: Ln FDI 1984-1988

Model 1 Model 2 Model 3 Model 4 Model 5 Model 6

National Incomes 0.88*** 086*** 0.83*** 0.84*** 0.87*** 0.89***

(0.09) (0.09) (0.09) (0.10) (0.09) (0.09)

Distance -0.47*** -0.43*** -0.40*** -0.42*** -0.43*** -0.44***

(0.12) (0.11) (0.11) (0.12) (0.11) (0.11)

Historical Ties 1.32*** 1.25***

(0.36) (0.36)

Cultural Distance -0.21 -0.28* -0.10

(0.15) (0.16) (0.16)

Common Language 1.83*** 1.91***

(0.46) (0.44)

Adjusted R2 0.47 0.51 0.51 0.48 0.53 0.53

N 149 149 149 149 149 149

Notes: Standardized regression coefficients reported; standard errors are in parenthesis. Significance levels: † p < 0.10, * p < 0.05, ** p < 0.01, *** p < 0.001.



1. FDI 1989-1993 199 6.61 2.28


199 25.62 1.49 0.64**

3. Distance 199 8.21 1.14 -0.42** -0.23**

4. Historical Ties 199 0.15 0.35 0.26** 0.11 -0.11

5. Common Language 199 0.10 0.29 0.25** 0.02 -0.08 0.59**

6. Cultural Distance 199 0.42 0.88 -0.33** -0.28** 0.29** -0.17* -0.30**

* p < 0.05. **p < 0.01.

Appendices

143


Independent Variables Dependent Variable: Ln FDI 1989-1993


National Incomes 0.88*** 0.85*** 0.81*** 0.82*** 0.85*** 0.88***

(0.09) (0.09) (0.09) (0.09) (0.09) (0.09)

Distance -0.58*** -0.54*** -0.49*** -0.51*** -0.51*** -0.53***

(0.12) (0.12) (0.12) (0.13) (0.12) (0.12)


(0.36) (0.36)

Cultural Distance -0.30* -0.38** -0.17

(0.16) (0.16) (0.16)


(0.44) (0.42)

Adjusted R2 0.44 0.49 0.50 0.45 0.50 0.50

N 192 192 192 192 192 192



Independent Variables Dependent Variable: Ln FDI 1994-1998


National Incomes 0.89*** 0.87*** 0.84*** 0.85*** 0.87*** 0.89***

(0.08) (0.08) (0.08) (0.08) (0.08) (0.08)

Distance -0.56*** -0.53*** -0.49*** -0.51*** -0.51*** -0.53***

(0.11) (0.10) (0.11) (0.11) (0.10) (0.10)


(0.33) (0.33)

Cultural Distance -0.21 -0.27* -0.10

(0.14) (0.14) (0.14)


(0.40) (0.38)

Adjusted R2 0.48 0.50 0.52 0.48 0.52 0.52

N 199 199 199 199 199 199


145

Appendix E: Structure of interview guide and topics covered during interviews Personal information interviewee E.g. position, previous employment history Personal familiarity perceptions and effects of experience Self-perceived understanding of local market and host context

! Before/upon entry ! Post entry

Rationalization of perceived understanding Reflection on degree of actual understanding of local market and host context


Reflection on shifts in perceived understanding of local market and host context Organization-wide perceived familiarity with local host context Organization-wide perceived understanding of local market and host context


Rationalization of organization-wide perceived understanding Degree of actual organization-wide understanding of local host context


Reflection on shifts in organization-wide perceived understanding of local host context Rationale for key internationalization decisions Rationale for:

Host market selection Timing of market entries Entry-mode decisions Current mode of operation and shifts in mode of operation


146

Organizational MNE model Degree of:

Decentralization of decision-making Organizational capabilities Interdependency between subsidiaries and headquarters

Intra-organizational dissemination of knowledge Discussion of local idiosyncrasies Interviews were semi-structured, and topics were added or left out depending on the position of the interviewee.

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Nederlandse samenvatting

Het vakgebied internationale bedrijfskunde houdt zich bezig met de vraagstukken en de analyse van problemen op organisatieniveau die voortkomen uit grensover-schrijdende activiteiten. Een centraal vraagstuk daarbij is welke factoren van invloed zijn op de internationalisatiebeslissingen van organisaties; zowel omtrent de landen-keuze van ondernemingen als omtrent de manier waarop ondernemingen in het buitenland opereren. Dit proefschrift gaat in op dit vraagstuk. Gesteld wordt dat de dominante theorie waarmee het internationalisatieproces van bedrijven verklaard wordt—het bijna 40 jaar oude Uppsala model c.q. internationalization process theory—fundamenteel moet worden aangepast om de complexe dynamiek van inter-nationalisatieprocessen te kunnen verklaren en om een consistente en gefundeerde gedragsmatige verklaring te kunnen geven van internationalisatieprocessen en inter-nationalisatiebeslissingen.

In hoofdstuk 1 wordt een korte introductie gegeven van internationalization process theory en van de empirische en theoretische problemen die de aanleiding vormen tot de studies in dit proefschrift. Ondernemingen die besluiten buiten de landsgrenzen te opereren worden geconfronteerd met een aantal tekortkomingen. Allereerst ontbreekt het deze ondernemingen, naast voldoende middelen, vaak aan voldoende inzicht in buitenlandse markten en vestigingscontexten. Daarnaast ontbreekt het deze ondernemingen ook aan ervaring in het opzetten en organiseren van buitenlandse activiteiten. Het uitgangspunt van het gedragsmatige Uppsala model—of internatio-nalization process theory—is dat de onzekerheid die ontstaat door dit gebrek aan kennis en ervaring van grote invloed is op internationalisatiebeslissingen; zowel als het gaat om de locatiekeuze als om de vorm waarin bedrijven besluiten een buitenlandse markt te betreden. Internationalization process theory neemt aan dat dit terug te zien is in het internationalisatiepatroon van bedrijven: bedrijven zouden een voorkeur hebben voor landen die relatief veel overeenkomsten vertonen met het thuisland, zoals in cultureel, politiek of taalkundig opzicht, en de mate van betrokkenheid van bedrijven in andere landen zou slechts geleidelijk toenemen naarmate bedrijven ter plaatse meer ervaring opdoen.

De aanleiding voor het onderzoek in dit proefschrift is tweeledig. Op de eerste plaats levert empirisch onderzoek naar de voorspellingen van internationalization process theory tegenstrijdige onderzoeksresultaten op. Het gevolg is dat nog steeds geen


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overeenstemming bestaat over de exacte factoren die van invloed zijn op internatio-nalisatiebeslissingen. Daarnaast is er in theoretische zin sinds de ontwikkeling van het Uppsala model—eind jaren 60 en begin jaren zeventig—weinig vooruitgang geboekt. De aannames en voorspellingen van internationalization process theory zijn nu al bijna veertig jaar ongewijzigd gebleven, en dat terwijl er sindsdien aanzienlijke vooruitgang is geboekt ten aanzien van onze kennis van menselijke besluitvorming en leer-processen in organisaties.

Dit vormt de aanleiding voor een kritische heroverweging van de twee belangrijkste aannames van internationalization process theory, namelijk dat bedrijven geneigd zijn landen te vermijden die in cultureel en sociaal-economisch opzicht verschillen van het thuisland, en dat kennis van buitenlandse markten en de vestigingscontext de belangrijkste motivatie vormt achter internationalisatie-beslissingen. In dit proefschrift worden deze aannames conceptueel in twijfel getrokken, en zowel op kwantitatieve als kwalitatieve wijze geëvalueerd door middel van de analyse van buitenlandse investeringspatronen en een studie naar het internationalisatieproces van een groot Duits dagbladconcern. Op basis van deze studies wordt een eveneens gedragsmatige maar alternatieve verklaring gegeven van de factoren die van invloed zijn op internationalisatiebeslissingen.

In hoofdstuk 2 worden de theoretische uitgangspunten van internationalization process theory besproken en bekritiseerd, en wordt de basis gelegd voor het centrale argument van dit proefschrift. De hier ontwikkelde kritiek kan als volgt worden samengevat. Op de eerste plaats negeert internationalization process theorie, door de rol van ervaringskennis sterk te benadrukken, dat andere factoren ook een rol spelen bij menselijke besluitvorming. De aanname dat internationalisatiebeslissingen gebaseerd worden op de daadwerkelijke kennis die bedrijven hebben van de vestigingscontext, en dat zonder kennis hiervan commitments in een buitenlandse markt worden uit- of afgesteld, is daarom onnodig restrictief. Op de tweede plaats is de gesuggereerde relatie tussen landenverschillen en onzekerheid—waarvoor internationalization process theory het construct psychische (subjectieve) afstand introduceert—onderontwikkeld en niet overtuigend. Het laatste punt van kritiek is dat internationalization process theory inconsistent is als het gaat om de vraag wat nu de onzekerheid omtrent internationalisatiebeslissingen veroorzaakt: terwijl de onzekerheid die bedrijven ervaren binnen buitenlandse markten gerelateerd wordt aan een gebrek aan kennis, wordt de onzekerheid ten aanzien van verschillende buitenlandse markten gerelateerd aan (absolute) verschillen tussen landen.

Hiermee ziet internationalization process theory enkele belangrijke aspecten van de menselijke besluitvorming over het hoofd; in het bijzonder dat beslissingen niet alleen worden gebaseerd op zowel de beperkte kennis en informatie die voorhanden is maar ook op basis van de veronderstellingen en aannames die besluitvormers voor waar houden. Bovendien laat internationalization process theory na om te benadrukken dat,


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aangezien de psychische—subjectieve—afstand ten aanzien van landen draait om een perceptie, de oorzaak van de psychische afstand die wordt ervaren gerelateerd is aan iemands kennisstructuur. Het begrijpen van de psychische afstand die besluitvormers ervaren ten aanzien van landen vereist daarom een cognitieve verklaring en is niet, of niet alleen, te verklaren in termen van (absolute) verschillen tussen landen.

In hoofdstuk 2 wordt gesteld dat internationalization process theory moet worden aangepast door de veronderstelde mate van bekendheid (familiarity perceptions) een centrale rol te geven bij de verklaring van internationalisatiebeslissingen. Uitgelegd wordt dat de veronderstelde mate van bekendheid met andere landen zowel gebaseerd is op daadwerkelijke kennis, als op overtuigingen en aannames. Aangezien de ver-onderstelde mate van bekendheid en onzekerheid omgekeerd evenredig zijn, wordt beargumenteerd dat een gebrek aan veronderstelde bekendheid met een buitenlandse vestigingscontext daarom de voornaamste oorzaak is van de onzekerheid omtrent internationalisatiebeslissingen.

Om in hoofdstuk 4 dit idee te kunnen toetsen—door het daadwerkelijke effect van landenverschillen op buitenlandse investeringspatronen kritisch tegen het licht te houden—wordt in hoofdstuk 3 eerst een institutionele afstandsmaat ontwikkeld. Hoewel er recentelijk hernieuwde aandacht is ontstaan voor het effect van bijvoorbeeld culturele, politieke en religieuze landenverschillen op locatiekeuze, wordt het mogelijke effect van inhoudelijke institutionele verschillen tussen landen—waarbij gedacht moet worden aan sociaaleconomische verschillen zoals verschillen in de rol van de staat, de aard van het financiële stelsel en verschillen in onderwijssysteem—in kwantitatieve studies zelden meegenomen wegens het gebrek aan een geschikte institutionele afstandsmaat. In hoofdstuk 3 wordt daartoe een nieuwe institutionele afstandsmaat ontwikkeld, en gevalideerd door middel van clusteranalyse.

De resultaten van de clusteranalyse bevestigen niet alleen de validiteit van de ontwikkelde afstandsmaat, maar leveren ook voor het eerst systematisch verkregen kwantitatief bewijs voor de verschillende sociaaleconomische basismodellen die in de literatuur—op basis van beschrijvingen van een relatief klein aantal landen—worden onderscheiden. Daarnaast suggereren de resultaten van de clusteranalyse dat aan de in de literatuur erkende basismodellen een nieuw empirisch te onderscheiden basismodel moet worden toegevoegd, namelijk het sociaaleconomische model van een aantal kleine Noord-Europese open economieën waaronder Nederland en Denemarken. Dit basismodel onderscheidt zich onder andere door een relatief indirecte betrokkenheid van de staat, een relatief grote mate van vertrouwen tussen economische actoren, en een relatief sterk onderwijssysteem.

De maatstaf ontwikkeld in hoofdstuk 3 wordt vervolgens toegepast in hoofdstuk 4, waarin het effect van de veronderstelde mate van bekendheid met andere landen op locatiekeuze wordt verkend. Daartoe wordt in dit hoofdstuk de mate onderzocht


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waarin zowel verschillende typen landenverschillen als historische banden tussen landen—een variabele die geassocieerd wordt met de veronderstelde mate van bekendheid—het patroon van internationale investeringen beïnvloeden. Ook wordt in meer detail beargumenteerd dat de veronderstelde mate van bekendheid met andere landen een belangrijke dimensie vormt van de ervaren psychische afstand tot landen.

De resultaten bevestigen de hypothese dat historische banden een significant effect hebben op de locatie van investeringen. Hetzelfde geldt overigens voor verschillen in taal en industriële ontwikkeling, en het effect van historische banden is aanzienlijk kleiner dan de aantrekkelijkheid van buitenlandse markten in termen van afstand en omvang. Daarentegen wordt in tegenstelling tot de voorspellingen van internationalization process theory geen bewijs gevonden voor de idee dat onderne-mingen een voorkeur hebben voor investeringen in landen die in cultureel, institutioneel, politiek, religieus of onderwijskundig opzicht sterker lijken op het thuisland. De bevinding dat historische banden wél een significant effect hebben op investeringspatronen steunt de hypothese van dit proefschrift over het belang van de mate van veronderstelde bekendheid en betwist de aanname van internationalization process theory dat de mate van onzekerheid ten aanzien van andere landen vooral afhankelijk is van verschillen tussen landen.

Terwijl de kwantitatieve studie in hoofdstuk 4 het effect verkent van veronderstelde bekendheid op locatiekeuze, wordt in hoofdstuk 5 gebruik gemaakt van een kwalitatieve casestudie om het effect te verkennen van veronderstelde bekendheid op de ontwikkeling van de mate waarin ondernemingen zich committeren aan landen. Onderwerp van de casestudie is het internationalisatieproces van een groot Duits dagbladconcern, dat veel minder geleidelijk verloopt dan men zou verwachten op basis van internationalization process theory: in elk van de Centraal Europese landen waarin de uitgever besluit te opereren wordt gekozen voor een relatief hoge mate van betrokkenheid. Aan de hand van interviews en documentatie worden in dit hoofdstuk de motieven onderzocht voor deze beslissingen.

De resultaten illustreren allereerst dat de veronderstelde mate van bekendheid niet alleen de locatiekeuze beïnvloedt (zie hoofdstuk 4), maar ook de mate van activiteit binnen een buitenlandse markt. Geïllustreerd wordt dat internationalization process theory over het hoofd ziet dat bij gebrek aan daadwerkelijke kennis internationali-satiebeslissingen ook gebaseerd kunnen worden op ongefundeerde veronderstellingen en aannames over de aard van een buitenlandse vestigingscontext. Sterke veronder-stellingen en aannames kunnen een gedeelte van de onzekerheid ten aanzien van een buitenlandse vestigingscontext ondervangen en er daardoor toe leiden dat onder-nemingen zich sterker committeren aan een nieuwe buitenlandse markt dan op basis van hun daadwerkelijke kennis en ervaring met dat land verwacht zou worden. Internationalization process theory ziet dus onterecht de effecten van subjectieve veronderstellingen en aannames op internationalisatiebeslissingen over het hoofd.


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Daarnaast wordt in dit hoofdstuk ook gewezen op de mogelijke reacties van multinationale ondernemingen wanneer de ontoereikendheid van veronderstelde kennis aan het licht komt. Hoofdstuk 5 illustreert ondermeer dat de onverwachte volharding van de Duitse uitgever in de gekozen wijze van toetreding in Hongarije beter te begrijpen is wanneer ook wijzigingen in het organisatiemodel van de onderneming in de analyse worden meegenomen. Zo wordt onder andere aangetoond dat internationalisatiebeslissingen vaak onderling gerelateerd zijn en dat—in tegenstelling tot de trend in internationaal bedrijfskundig onderzoek naar sterk afgebakende specialistische studies—het dus juist holistische, multidisciplinaire studies zijn die op dit terrein nieuwe inzichten kunnen verschaffen.

In hoofdstuk 6 worden de resultaten van de studies in dit proefschrift samengebracht. Wat duidelijk wordt is dat, naast de aantrekkelijkheid van buitenlandse markten, het internationalisatieproces van ondernemingen vooral beïnvloed wordt door de mate van veronderstelde bekendheid met buitenlandse markten. Internationalisatie-beslissingen worden namelijk niet alleen gebaseerd op de daadwerkelijke kennis, maar ook op basis van de veronderstellingen en aannames die besluitvormers voor waar houden over zowel de aard van buitenlandse markten en vestigingscontexten als over de juiste manier om de buitenlandse activiteiten van de onderneming te organiseren.

Dit proefschrift eindigt door te stellen dat door het effect van veronderstelde bekendheid op internationalisatiebeslissingen in beschouwing te nemen ook de te verwachten dynamiek van internationalisatieprocessen verandert. Internationaal onervaren ondernemingen kiezen niet zozeer voor landen die relatief veel over-eenkomsten vertonen met het thuisland, maar voor landen die als relatief bekend worden ervaren. Door internationale ervaring worden ondernemingen meer bekwaam in zowel het organiseren van hun internationale activiteiten als in het leren over nieuwe buitenlandse markten. Dit leidt tot een reductie van de onzekerheid ten aanzien van andere, minder bekende, buitenlandse markten, wat het betreden van nieuwe buitenlandse markten vervolgens verder stimuleert. Daarnaast verlopen internationalisatieprocessen niet noodzakelijkerwijs geleidelijk. In de praktijk compenseren aannames, generalisaties en vooroordelen vaak gedeeltelijk de onzeker-heid die voortkomt uit een gebrek aan daadwerkelijke kennis, wat kan aanzetten tot substantiële commitments.

De studies in dit boek illustreren dus dat de gedragsmatige dynamiek die ten grondslag ligt aan internationalisatieprocessen verre van eenvoudig is. Of en welke landenverschillen internationalisatiebeslissingen beïnvloeden kan afhankelijk zijn van de manier waarop een bedrijf een buitenlandse markt betreedt. Daarnaast gaan internationale leerprocessen ook gepaard met het ontleren van aannames die wellicht juist de fundering vormden voor eerdere beslissingen. De reactie van multinationale ondernemingen op zulke correcties is al even complex en hangt onder andere samen met de vraag of ontkrachte aannames betrekking hebben op de buitenlandse


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vestigingscontext of op de veronderstelde strategische vereisten van de bedrijfstak waarin een onderneming opereert. Hoewel in de literatuur geopperd is dat gedrags-matige internationalisatietheorieën tegenwoordig van weinig waarde zijn voor het vakgebied internationale bedrijfskunde, illustreert dit proefschrift dat, mits de voorge-stelde wijzigingen in internationalization process theory worden meegenomen, deze gedragsmatige benadering juist zeer interessante kansen biedt voor vervolgonderzoek.

Documents

Internationalization Decisions: The Effects of Country Similarities